Pimco's Gross: Longer-Term Bond Yields Have Bottomed

Longer-term U.S. Treasury bond yields have bottomed and will steadily rise because of inflation pressures as the U.S. economy clambers out of the current downturn, the manager of the world's biggest bond fund wrote Monday.

Bill Gross

"Intermediate and long-term yields on government bonds have already bottomed and will gradually rise" during the term of the next president, due to start in January, wrote Bill Gross, chief investment officer of Pacific Investment Management Co., or PIMCO, in his monthly "Investment Outlook" letter for July.

The benchmark 10-year Treasury note's yield, which moves inversely to its price, dipped to 3.285 percent in January, the lowest since 2003, on signs of a weakening economy and escalating credit market strains.

But since then, surging commodity prices and rising inflation expectations have pushed the 10-year yield up by about one percentage point, to above 4.30 percent last week.

Over time, current negative real interest rates, the Federal Reserve's extraordinary liquidity provisions to the banking system and the government's fiscal stimulus measures should promote reflation, Gross said.

"This economy will need an additional jolt of $500 billion or so of government spending real quick," he wrote.

Open Letter to Obama

This month's investment outlook letter was addressed to Democratic White House hopeful Barack Obama, as if he had been elected.

The next president has little choice but to step up fiscal stimulus to revive the economy, Gross said.

"You've inherited an asset-based economy whose well has been pumped nearly dry with lower and lower interest rates and lender of last resort liquidity provisions," he wrote. "Your administration will produce this nation's first trillion dollar deficit."

Foreign central banks and private investors may not continue to buy Treasurys at the same rate as in previous years a trend that has kept Treasury yields lower than they would otherwise be. Absent these low interest rates to aid the economy, "what you need now is fiscal spending and lots of it," Gross wrote.

The housing market's decline will continue, he forecast.

By January, U.S. home prices will have fallen nearly another 10 percent, "and our Japanese-style property deflation will be in full stride," Gross wrote.

Japan's real estate markets crashed in the early 1990s and have yet to fully recover.

"Dear President Obama," the letter began. "You have inherited a mess. Your predecessor, fixated on emulating a former Republican icon from a far different economic era, chose to emphasize tax cuts for the rich and excessive consumption for all Americans," Gross wrote. "He promoted deregulation and free markets when, in fact, the markets and their institutions needed tough love."