PIMCO's Gross Sees Fed Funds at 3% by Midyear

The Federal Reserve will cut lending rates aggressively in the first half of 2008 as the United States faces a possible recession, PIMCO fund manager Bill Gross said in an investment outlook posted on Tuesday.

Bill Gross
Bill Gross

The federal funds rate, the Fed's key policy tool, will likely be cut to 3 percent by mid-year, said Gross, chief investment officer of Pacific Investment Management Company, in Newport Beach, California.

The Federal Open Market Committee has cut the funds rate by 100 basis points since mid-September, to 4.25 percent.

Policy-makers meet on January 29-30 to mull their next move. Financial markets are confident of a rate cut of either 25 basis points or 50 basis points.

Gross said losses from credit default swaps gone awry could be the next shoe to fall for vulnerable financial markets and the overall economy.

The "protection selling party" in the CDS market could face losses of $250 billion, he said.

Between CDS losses and prospective losses in commercial real estate and credit cards in 2008, "you have a recipe for a contraction in credit, leading to a recession," Gross said.

He termed credit default swaps the most egregious offenders in a "shadow banking system" that has sprung up to dodge traditional market regulations.

"Of course, 'buyers of protection' will be on the 'winning' side, but the point is that as capital gains and capital losses slosh from one side of the shadow system's boat to the other, casualties and shipwrecks are the inevitable consequence," Gross said.