Bill Gross released his latest Investment Outlook today on PIMCO’s website and has some interesting comments on what will happen to bond yields when the Fed discontinues Operation Twist at the end of June.
“It’s the quantity of securities held by the Fed at a given time, rather than the new purchases, the flow of new purchases, which is the primary determinant of interest rates.”
Gross said that theory “is somewhat incomprehensible to me.” He doesn’t believe that the market will gobble up future supply of Treasuries because private stockpiles have been depleted.
[The Fed believes] much like a wine cellar, I suppose, that is now nearly empty because policymakers have been drinking the rare vintages, wine lovers will now be forced to restock their cellars to get a historically comfortable inventory. Hmmm, being a beer drinker myself, I might otherwise assume that appetites might switch due to higher prices (and lower yields). And if wine or bonds were mandated to fill the cellar, then why not a foreign wine or a foreign bond?
He also suggests real assets (like commodities or real estate) will be attractive alternatives. The takeaway for FX, if Gross is right, is that the flows out of the US will end up in countries that are offering higher rates, less central bank interference and commodities — AUD, CAD, NZD and emerging markets.
A rise in bond yields wouldn’t be all bad for the US dollar because it would likely boost USD/JPY — at least until Bernanke realizes he was wrong and fires up the printing presses again.
