Central bankers could miss a possible economic reversal by adhering to historical models in a period of extraordinary monetary policy, Janus Henderson Investors bond manager Bill Gross argues.
In his monthly investment outlook, Gross warns he is cautious on the normalising of short-term rates due to the proportional impact it would have on borrowers.
Economists and some Fed officials have been lulled into believing a recession is no where in sight with the current spread of 80 basis points between three-month Treasury Bills and 10-year Treasuries, Gross says.
US recessions in the last 25 years have coincided with a flat yield curve and economists therefore view the trigger point of zero as far off, Gross says.
“The adherence of Yellen, Bernanke, Draghi, and Kuroda, among others, to standard historical models such as the Taylor Rule and the Phillips curve has distorted capitalism as we once knew it, with unknown consequences lurking in the shadows of future years,” Gross notes.
Gross argues while an 85 basis point increase is required in three-month Treasuries to flatten the yield curve that would represent a near doubling in the cost of short-term finance.
The same increase during the 1991, 2000 and 2007 recessions would have produced only a 10 per cent to 20 per cent rise in short-term rates. This means a much “less flat” curve to signal the beginning of a possible economic reversal.
“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 says.
He points out that since the start of quantitative easing, over $15trn of sovereign debt and equities “overstuff” central bank balance sheets in a “desperate effort to keep global economies afloat”.
At the same time, over $5trn of investment grade bonds trade at negative interest rates.
“Central bankers and indeed investors should view additional tightening and “normalising” of short term rates with caution.”