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PIMCO Chief Sees Yields Dropping on 10-Year Treasury

In an exclusive interview on cnbc.com's home page, PIMCO chief William Gross said he expects yields on the 10-year Treasury bond to drop to the high 2%-to-low 3% range because of the slowing economy.

Yields on the 10-year are currently running at about 4.44%.

Gross also said the Federal Reserve will have to cut rates next year to jump-start the economy.

"We continue on with our outlook for slower economic growth in the U.S. and the rest of the world," Gross told CNBC's Steve Liesman during the live interview.

The bond market is already pricing in expectations for a Fed rate cut within the next 24 months, said Gross, who is chief investment officer of Pacific Investment Management, or PIMCO, the world's largest bond fund.

In recent days, Federal Reserve policy makers have stuck with their stance that inflationary pressures are more of a risk than that of a slowing economy. However, Gross expects the Fed to change its message once unemployment numbers begin to creep up. The latest data on joblessness will be out this Friday.

Recent reports have indicated a modest decline in manufacturing activity. However, the services sector, which makes up more than 80% of the economy, is still growing.

According to Gross, the latest report on the non-manufacturing sector from the Institute for Supply Management, which showed the index at its highest level since May, is not enough to offset other signs of economic weakness.

"The last time we had a recession, in 2000 and 2001, the service number didn't break (below) 50 until the recession began, and it lagged the manufacturing sector breaking 50 by nine months," Gross said.

Gross believes the Fed's stance on rates will hinge more on employment than any specific production data.

Gross is expecting December employment data out this Friday to be "lackluster." He said the weakness in the housing market hasn't been fully reflected in the employment data yet as some workers were completing housing projects that began prior to the downturn in the sector. As those jobs are completed, unemployment will creep up, Gross said.

For those who disagree with Gross's take on interest rates, he recommends holding cash rather than buying bonds based on current yields. This is particularly true of the two-year Treasury note, he said.

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