Gross on Threats to Economy Going Forward

The quantitative easing that has occurred in the post-Lehman era has led to a situation, writes fund manager Bill Gross in a recent Barron’s article, where central bank balance sheets are replete with equities “in a desperate effort to keep global economies afloat.”

Concurrently, he argues, more than $5 trillion of investment grade bonds “trade at negative interest rates in what can only be called an unsuccessful effort to renormalize real and nominal GDP growth rates.” This environment, he warns, presents a degree of economic uncertainty down the road because both central bankers and private economists rely on historical models (the article cites the Taylor Rule and the Phillips curve as two examples) that suggest a negative yield curve can be a precursor to recession. “Since the current spread of 80 basis points is far from the ‘triggering’ spread of 0, economists and some Fed officials as well, believe a recession can be nowhere in sight.”

But Gross argues that even a flattening of the yield curve in today’s economy would represent a nearly doubling of the cost of short term debt. Given the increasingly levered domestic and global economy, he argues, this can lead to trouble. The most “destructive” leverage, he writes, occurs at the short end of the yield curve, which leads to higher monthly interest payments—which can be more easily absorbed by governments than it can by corporations and individuals. “The cost of short-term finance should not have to rise to the level of a 10-year Treasury note to produce recession.”