Recent headlines have investors wondering which school of thought should guide them when considering Treasuries – that of Ben Bernanke or Bill Gross.
Ben Bernanke, chairman of the Federal Reserve, assured Congress this month that his Quantitative Easing program is having positive effects on the economy, and that the fed is planning for a smooth exit when the program ends on June 30, 2011. Under QEII the Federal Reserve is purchasing up to $600 billion in federal debt in efforts to curb interest rates, bolster the stock market, create jobs and encourage spending.
Bill Gross, manager of PIMCO’s Total Return Fund, has eliminated U.S. government debt from the $237 billion fund in anticipation of higher yields for Treasuries. Higher yields would lower the value of current bond holdings. “Who will buy Treasuries when the Fed doesn’t?” Gross asks in a March Investment Outlook for PIMCO.
“A successful handoff from public to private credit creation has yet to be accomplished, and it is that handoff that ultimately will determine the outlook for real growth … ,” Gross said. “If on June 30, 2011 … the private sector cannot stand on its own two legs – issuing debt at low yields and narrow credit spreads, creating the jobs necessary to reduce unemployment and instilling global confidence in the sanctity and stability of the U.S. dollar – then the QEs will have been a colossal flop.”
Success or flop? Wall Street and the rest of the world are awaiting the outcome. As Gross explains it, private investors – who typically account for 40 percent of Federal debt purchases - have been crowded out by the Federal Reserve, which has bought 70 percent of recent Treasury issues. Foreign creditors, particularly China and Japan, have bought the remainder.
Will private investors step back in to fill the void left by the Federal Reserve? “The question really is at what yield and what are the price repercussions,” Gross said. “Yields may have to go higher, maybe even much higher to attract buying interest.”
Meanwhile, Bernanke assures us, “We have all the tools we need to achieve a smooth and effective exit at the appropriate time.”