In the latest edition of his widely followed monthly outlook, Janus Henderson Investors’ bond guru Bill Gross warns that the steps central bankers are taking to normalize rates could lead to recession.
Per his usual style, Gross opens the outlook with a colorful — if disturbing — anecdote about John McSherry, the 320-pound umpire who suffered a massive heart attack, collapsed, and died behind the plate seven pitches into a 1996 baseball game in Cincinnati. Gross then invokes the protagonist of Franz Kafka’s “A Hunger Artist,” who died starving himself, to illustrate the failings of human beings to control their appetites, or lack of thereof. Gross’s conclusion? Like human beings with any addiction or mental illness beyond their control, central bankers are also unable to get rational on monetary policy.
“Monetary policy in the post-Lehman era has resembled the gluttony of long departed umpire John McSherry — they can’t seem to stop buying bonds, although as compulsive eaters and drinkers frequently promise, sobriety is just around the corner,” wrote Gross, who manages the Janus Henderson Global Unconstrained Bond Fund.
Gross added that since central banks around the world embarked on their quantitative easing programs following the global financial crisis of 2008, “over $15 trillion of sovereign debt and equities now overstuff central bank balance sheets in a desperate effort to keep global economies afloat.” At the same time, more than $5 trillion of global bonds are now trading at negative interest rates, which Gross argued “can only be called an unsuccessful effort” to normalize real and nominal GDP growth rates.
What’s more, Gross says, central bankers are using models to guide their rate hike path that are no longer appropriate given their extraordinary actions.
“The adherence of Yellen, Bernanke, Draghi, and Kuroda, among others, to standard historical models” has “distorted capitalism as we once knew it, with unknown consequences lurking in the shadows of future years,” he wrote, alluding to Federal Reserve Chairman Janet Yellen, previous Fed Chair Ben Bernanke, European Central Bank president Mario Draghi, and Bank of Japan Governor Haruhiko Kuroda.
These models, Gross notes, attempt to prove that recessions are the result of negative yield curves, or what happens when yields on short-term debt instruments are higher than those on long-term debt instruments. He reminds readers that the three recessions that have occurred in the past 25 years coincided with a flat yield curve between 3-month Treasuries and 10-year Treasuries. Economists and Fed officials think that because the current spread is now 80 basis points — nowhere near the “triggering” spread of 0 — then a recession is not on the horizon.
But, he argues, given the amount of leverage in the system today, “the cost of short-term finance should not have to rise to the level of a 10-year Treasury note to produce recession.”
He points out that an 85 basis point increase in today’s interest rate world would almost double the cost of short-term financing for companies. The same 85 basis point increase prior to recessions in 1991, 2000 and 2007-2009 would have only increased the cost of financing by 10 to 20 percent, a huge differential.
“Today’s highly levered domestic and global economies which have ‘feasted’ on the easy monetary policies of recent years can likely not stand anywhere close to the flat yield curves witnessed in prior decades,” Gross wrote.
He concludes by warning that central bankers and investors should view additional tightening and normalizing of short-term rates with extreme caution.
