Pimco: Fed Needs to Use Its Balance Sheet More Aggressively

The gang at Pimco often is accused of talking their book. Hey, why not, given Bernanke has been known to lob in calls to them looking for color and even advice.

They have gotten a lot right over the past nine months, as evidenced by their performance. But they are not universally loved, and will certainly provoke howls of protest over their latest solution for what ails us:

In addition to the alternative credit facilities the Fed has recently provided, first to banks and then to broker-dealers, we expect the Fed to more aggressively use its balance sheet. They don’t just need to lend against mortgage collateral via enlarged Treasury auction facilities and term repo operations, they need to buy mortgage collateral outright. This is, at the margin, a quasi fiscal policy action, in that any losses the Fed were to take would reduce the seinorage rebates it pays the Federal government on the profits and interest generated by its portfolio. This makes it a politically difficult step for the Fed, but it is a step we think they will take, as the political climate evolves toward recognition that all tools must be employed. PIMCO

Pimco's quarterly Cyclical Economic Forum, a gathering of their team from across the globe, has come to the conclusion the U.S. is likely to experience negative GDP growth in the months ahead, and has taken their hatchet to Euro Zone growth as well.

They are starting to waver on the decoupling theory that Asia, ex-Japan, will remain the engine of growth. All in all, it is a bleak outlook, with all their key assumptions deteriorating from their meeting held three months ago.

Moral hazard arguments have dominated the headlines, and they are unlikely to diminish as we move down this road:

......some form of direct fiscal support of the property market is also needed and is very likely to be forthcoming. Many options are on the table, but at the end of the day, they all involve the simple proposition that Uncle Sam must guarantee refinanced underwater mortgages, with large principle write- downs. This would most likely be accomplished through the Federal Housing Authority in concert with Fannie Mae and Freddie Mac. Although political momentum on this type of fiscal action has not yet reached critical mass, it is clearly moving in that direction, and we feel very confident that it will.

Politicians might be working up their courage, but traders already have, homebuilding stocks are among the best year-to-date performers as bulls try to handicap the future and gun for the shorts in the crowded names.

And unlike hedge funds, Pimco is willing to open up their playbook for the months ahead:

The greater and more forceful the policy response beyond the Fed’s aggressive moves so far, the more we plan to shift from curve and duration to spread products. If policy makers are unambiguously targeting spread product – if they are writing a put on spread duration – then you want to own spread product..... We have been betting very heavily and very successfully on the Fed Funds instrument, both with respect to duration and even more importantly with respect to curve, and that will be moderated in favor of spread duration and high grade assets.

Deleveraging in the shadow bank system is leading to mispricing in high quality assets and Pimco is happy to accomodate the sellers who have no other choice.

Price discovery is a bitch, especially when your only option is to hit Bill Gross’ lowball bid.

If you are pressed for time, you can read the Cliffnotes version on Pimco’s commentary, summed up in the following sentence:

Until property deflation is stopped, nothing else is going to work in our economy.

Fair warning, reading their commentary will ruin your mood heading into the weekend.

Paul McCulley Discusses PIMCO’s Cyclical Outlook and Investment Strategy
Pimco

Comments:

<< Back to main