from Follow the Money

Bill Gross, no longer the bond king …

April 4, 2006

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Bill Gross of PIMCO certainly seems to think foreign central banks matter - despite the arguments from some in the Fed (and the Treasury).

Foreign central banks made famous and in fact prosperous by the miracles of globalization are the symbolic elephants of our new financial marketplace, and while they may stampede or charge only infrequently, they have stripped the bond market jungle of its formerly "alpha rich" vegetation and trampled the high grass such that today's global yields are but a wisp of their former selves. ... The universe of bond managers subject to Bill Clinton's invective it seems, has changed over the past five years. He'd now be swearing in almost every embassy and at millions of foreign citizens turned bond traders no matter which way he looked. The big "players" of bond trading past, such as banks, insurance companies, pension/mutual funds, and investment management companies which serve as their proxies, have been replaced or at least asked to take a seat on the bench in deference to the new first string.

I found his assessment of the impact of the yen carry trade on US markets even more interesting.

Gross writes:

In addition, profit-incented/yield-starved foreign individual investors have joined hedge funds and the PIMCOs of the marketplace in what has been called the Yen carry trade, substituting 0% yields in Japan for double-digit rates in emerging market bonds and currencies, high single-digits in spread product, and in turn "settling" for a mere 400-500 basis point pickup in good old fashioned U.S. Treasuries.  ....

Our [US] markets since mid-2004 that have been the main recipients of the Yen carry trade, a phenomena made possible by the widening spread of U.S. and Japanese short rates and the relative assurance by the BOJ that the Yen would not be allowed to appreciate significantly against the dollar. This one-sided bet has fostered the borrowing/exodus of money from Japan and the reinvestment of those funds in anything with a yield here in the U.S.

Gross' argument suggests that the yen carry trade has been big -- something that seems to fly against the conventional wisdom that the yen carry trade is a mere fraction of its (1998) self (there is a bit of background on the big 1998 carry trade unwinding in this Bloomberg story).

His views on the dollar?  Sort of like my own.

As global real interest rates converge, the export potential of comparative economies should begin to dominate exchange values and it is there, of course, where the U.S. is so critically deficient. Japan as we all know is an export powerhouse. Less well known is the ongoing ability of Germany as the center of Euroland to command global market share. The ascendancy of China's production for export is of course unquestionable. That leaves the U.S. with its increasingly hollowed out manufacturing core as the near certain loser in currency valuations going forward. To be blunt, the dollar must go down as it loses its carry.  ...

The real long-term risk in my opinion, is in holding dollars, and if so, absolute returns in global purchasing power will suffer if they are held.

Gross still sounds like a Buffetesque structural dollar bear.   He doesn't sound ready to capitulate.    Nor does Volcker.  Nor does Jim O'Neil of Goldman for that matter, even if he doesn't explicitly mention the dollar.

``It's always dangerous to be involved in countries with large current account deficits,'' says Jim O'Neill, Goldman Sachs Group Inc.'s chief global economist, who is based in London. ``This should be a lesson to people who do carry trades without looking at economic fundamentals.''

I guess that means the dollar is safe; the bears won't give up.

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