PIMCO's Gross: Stock Rebound May Be Premature

By Reuters

A recent "euphoric" rebound in stocks and non-government bonds may be premature as deeper home price declines threaten the economy and financial markets, the manager of the world's biggest bond fund said.

Bill Gross

Bill Gross, chief investment officer of Pacific Investment Management Co. (PIMCO), also warned that additional interest rate cuts by the Federal Reserve may do harm by weakening the dollar further and stoking inflation.

The Federal Reserve has slashed the benchmark U.S. federal funds target rate by 3 percentage points since September to 2.25 percent.

The Fed is expected to trim the rate by a quarter of a point when its policy meeting ends Wednesday, and many analysts then expect a pause in its rate-cutting campaign.

"Lower fed funds? They would, in PIMCO's opinion, likely do more damage than good from this point forward," Gross wrote in his May Investment Outlook letter on the company's Web site.

Gross often fashions his market outlook letters around literary or other popular culture analogies, this month choosing Erich Maria Remarque's World War I classic "All Quiet on the Western Front" as his central theme.

The letter -- likening the market turmoil of the past year to trench warfare -- warns investors against jumping too quickly to the conclusion that the bloodshed in financial markets is over, despite the comparative tranquility of financial markets in recent weeks.

Gross said his co-chief investment officer, Mohamed El-Erian, "suggests the possibility, not the probability, that recent euphoric moves in equity prices and credit market spreads might be premature."

Since the Federal Reserve and JPMorgan Chase & Co's rescue of Bear Stearns Cos in mid-March, the U.S. S&P 500 index has rebounded by about 9 percent to the highest levels since early January.

Safe-haven U.S. government bonds have sold off, with the 10-year note's yield, which moves inversely to its price, jumping half a percentage point.

Strains in credit markets have started to abate.

Last week, U.S. investment-grade corporate bond sales soared to a weekly record.

But the recent calm in markets may belie the possibility that a sharp economic contraction lies ahead, Gross said.

"Recession, and its vicious-cycle effect on employment and consumer spending, remains a threat, and this recession, although currently mild and as of yet not even officially validated, may not be your garden-variety ... downturn," Gross said.

"A continued housing deflation of several trillion more dollars now threatens to impact the real economy, which in turn might produce a reversal of financial market fortunes," Gross said.

He also expressed support for a proposal to aid troubled homewners from U.S. House Financial Services Committee Chairman Barney Frank of Massachusetts and U.S. Senate Banking Committee Chairman Christopher Dodd of Connecticut.

"The better alternative is to initiate a limited mark-to-market write-down of private mortgage debt as envisioned in the Dodd-Frank congressional proposal combined with government-subsidized loans at below-market rates," Gross wrote.

The Pimco Total Return Fund's total assets at the end of March were $125.1 billion, delivering a total return in the first quarter of 3.32 percent, according to the firm's Web site.