Next Fed Easing to Include Inflation Target: Gross

The Federal Reserve likely will launch its next round of quantitative easing later this month with language that will set a specific target for inflation, Pimco's Bill Gross told CNBC.

Bill Gross of PIMCO participates in a conference on the future of housing finance at the Treasury Department in Washington, DC.
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Bill Gross of PIMCO participates in a conference on the future of housing finance at the Treasury Department in Washington, DC.

With the economy faltering and stocks selling off aggressively, the central bank likely will have no choice but to announce more easing—QE3, in market parlance.

But the next round likely will look different than the first two, which focused on asset purchases such as Treasurys—as was the case with QE2—or an assortment of debt instruments, as with QE1.

Gross said the Fed could announce QE3 at its Jackson Hole, Wyo., summit scheduled for late August.

"We have a divided Fed so it's going to be difficult to re-enact the same form of QE2," said Gross, co-CEO of the largest bond fund manager in the world. "I don't think the Fed has a program in place to purchase Treasurys again. But what they do have in place a program for the language which speaks to an extended period of time, which ties language to an extended period of time."

The Fed has a variety of weapons at its disposable—more asset purchases, cutting the interest paid on reserves in order to get banks to lend more aggressively, or to use language regarding the time frame for its zero interest rate policy.

Gross speculated the Fed will vow to keep its funds rate target at a maximum of 0.25 percent as long as inflation stays at 2.5 percent or less.

"If that's the case, then Treasury prices can rally from this point forward," he said.

But that puts the Fed in a precarious position as the dollar continues to lose valueagainst the world's currencies and threatens runaway inflation.

"What the Fed has done with QE1 and QE2 and perhaps QE3 is basically support risk assets—stock prices and the like—by lowering interest rates, real interest rates in particular," Gross said. "So there is a limit in where they can go based on the strength and weakness of the dollar. The dollar cannot stand a continuing decline in interest rates because that leads to selling and currency pressure."

The dilemma is complicated by the need to do something to help the economy now that Washington is focused on debt reduction, which likely will hamper growth in the short term.

Gross said he is unimpressed by the new law passed raising the nation's $14.3 trillion debt ceiling, which he called "a 'Macbeth,' full of sound and fury and signifying nothing-type of event."

"Sorry, Tea Party, but you don't promote economic growth in the short term by reducing deficits," he said. "Obama and company should have been focused on jobs as opposed to this debt package, which took up a tremendous amount of time unnecessarily."