Bill Gross Asks The $64,000 Question: "Who Will Buy Treasuries When The Fed Doesn’t?" His Answer: "I Don't Know"; Gross Is Getting Out Of Risk

Tyler Durden's picture

After serving as the inspiration for the Chairsatan's latest appellation with his February missive, Bill Gross now goes for the jugular with the $64,000 question: with "nearly 70% of the annualized issuance since the beginning of QE II
has been purchased by the Fed, with the balance absorbed by those old
standbys – the Chinese, Japanese and other reserve surplus sovereigns.
Basically, the recent game plan is as simple as the Ohio State Buckeyes’
“three yards and a cloud of dust” in the 1960s. When applied to the
Treasury market it translates to this: The Treasury issues bonds and the
Fed buys them. What could be simpler, and who’s to worry? This Sammy
Scheme as I’ve described it in recent Outlooks is as foolproof
as Ponzi and Madoff until… until… well, until it isn’t. Because like at
the end of a typical chain letter, the legitimate corollary question is –
Who will buy Treasuries when the Fed doesn’t?" Bingo, we have a winner. This is precisely the issue that Zero Hedge has been exposing over the past 6 months, and is the reason why the Fed is now locked in a QEasing corner from which there is no exit. To his credit, Gross attempts to provide an answer: "Someone
will buy them, and we at PIMCO may even be among them. The question
really is at what yield and what are the price repercussions if the
adjustments are significant... What I
would point out is that Treasury yields are perhaps 150 basis points or
1½% too low when viewed on a historical context and when compared with
expected nominal GDP growth of 5%."
And the stunner: "Bond yields and stock prices are
resting on an artificial foundation of QE II credit that may or may not
lead to a successful private market handoff and stability in currency
and financial markets
. 15% gratuities may lie ahead, but more than
likely there is a negative two-bit or even eight-bit tip lying on the
investment table. Like I did 45 years ago, PIMCO’s not sticking around
to see the waitress’s reaction." Translation: Pimco just issued a "sell" rating on everything.

From Bill Gross March Outlook.

Two-Bits, Four-Bits, Six-Bits, a Dollar

  • 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 and stability.
  • Because quantitative easing has affected all risk spreads, the
    withdrawal of nearly $1.5 trillion in annualized check writing may have
    dramatic consequences.
  • Who will buy Treasuries when the Fed doesn’t? The question really is
    at what yield, and what are the price repercussions if the adjustments
    are significant.

The
Gross family legend is rather full of Paul Bunyan tall tales passed
down over the years but none perhaps more self- revealing than “The Day
When I Gave the Waitress a Negative Tip.” Admittedly I was young and
full of testosterone but the service was terribly sloooww and I was
in a big hurrrryyy! Finally presented with a $2.00 bill, I took two
bucks and wrote the following on a nearby napkin: “Thanks for the sh…ty
service, negative tip – you owe me 25 cents.” I didn’t stick around to
see the reaction, but I’m sure it was a unique experience for the young
lady. I was, of course, like any 21-year-old, in the business of
establishing a repertoire of “unique” experiences and this was but one
notch on my Paul Bunyan Axe.

These days, my negative two-bit tip would hardly leave a dent in the
estimated $25 billion annual pool of tips left at American restaurants.
No matter. What was revealing at the moment back in 1965 was what it
said about me: impatient, willing to disappoint people (at least
strangers) and a little inconsiderate of some people. Maybe a little
imaginative too. In any case, social scientists have recently confirmed
that tipping does send a message and that it is more about
the man or the woman in the mirror than the quality of the service. The
primary reason for tipping appears to be social approval. Theoretically
it is a power tool, a financial weapon that commands “treat or trick,”
but studies since the 1940s have shown that most people do not have the
requisite nerve to stiff a waitress even for unreasonable service. And
too, William Grimes, in The New York Times, pointed out a
decade ago that a waitress who touched her customers when asking if the
meal was OK, raised her tip from 11 to 14% of the tab. Waiters’ personal
introductions, as well as crouching at the table when taking an order,
also worked famously. And here’s an interesting tidbit: Solo diners
leave an average tip of 19.7% while a five-some drops all the way to
13.2%. Evidently, the size of the tip is a factor, and a reason why
restaurants charge 16%+ for groups of six or more. That surely would
have enraged Leo Crespi, who at the turn of the 20th century proposed
the formation of a National Anti-Tipping League. While ahead of his
time, he would likely play second fiddle to yours truly 65 years later
who invented the “negative tip.” Recently my 22-year-old son, Nick,
carved a notch on his own Paul Bunyan Axe with a negative $1.00 tip
adjusted for 45 years of inflation. Tip off the old block, I’d say!

Speaking of investment tips, no clue or outright signal could
have been any clearer than the one given in December 2008, labeled
“Quantitative Easing.” While the term was new, the intent was obvious:
(1) pump public money into the financial system to replace private
credit that was being destroyed in the process of deleveraging; (2)
lower interest rates on intermediate and long-term mortgages/Treasury
bonds and in the process flush money into risk assets – most visibly the
stock market; and (3) forecast publically then hope that higher stock
prices would lead to a wealth effect, and in turn generate new private
sector lending, job creation and a virtuous circle of economic expansion
that would heal the near-fatal wounds of Lehman and its aftermath. If
that was the game plan, then so far, so good, I’d say. Interest rates
are artificially low, stocks have nearly doubled since QE I’s first
announcement in December of 2008, and the U.S. economy will likely
expand by 4% this year, although a $1.5 trillion budget deficit must
share QE’s Oscar for most stimulative government policy of 2009/2010.

Many critics, though, including yours truly, would wonder whether
Quantitative Easing policies actually heal, as opposed to cover up,
symptoms of an unhealthy economy. They might at the same time ask
simplistically whether it is possible to cure a debt crisis with more
debt. As I have discussed in numerous Investment Outlooks, the odds of an ultimate
QE success seem critically dependent on several criteria: (1) initial
sovereign debt levels that are relatively low. Reinhart and Rogoff in
their book “This Time Is Different” have suggested an 80–90% of GDP
limit to sovereign debt levels before they become counterproductive; (2)
the ability of a country to print globally acceptable scrip –
especially enhanced if that nation has the reserve currency status now
ascribed to the U.S.; and (3) the willingness of creditors to believe in
future real growth as a rebalancing solution to current excessive
deficits and debt levels.

Most observers would agree with us at PIMCO that QE I and II programs
were initiated and employed under the favorable conditions of (1) and
(2). The third criterion (3), however, is more problematic. 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 and the potential reversal in our astronomical
deficits and escalating debt levels. If on June 30, 2011 (the assumed
termination date of QE II), 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. If so, there will be no 15%+ tip for
the American economy and its citizen waiters. An inflation-adjusted “negative buck” might be more likely.

Washington, Main Street – and importantly from an investment
perspective – Wall Street await the outcome. Because QE has affected not
only interest rates but stock prices and all risk spreads, the
withdrawal of nearly $1.5 trillion in annualized check writing may have
dramatic consequences in the reverse direction. To visualize the gaping
hole that the Fed’s void might have, PIMCO has produced a set of three
pie charts that attempt to point out (1) who owns what percentage of the
existing stock of Treasuries, (2) who has been buying the annual supply
(which closely parallels the Federal deficit) and (3) who might step up
to the plate if and when the Fed and its QE bat are retired. The
sequential charts 1, 2 and 3 are illuminating, but not necessarily
comforting.

What an unbiased observer must admit is that most of the publically
issued $9 trillion of Treasury notes and bonds are now in the hands of
foreign sovereigns and the Fed (60%) while private market investors such
as bond funds, insurance companies and banks are in the (40%) minority.
More striking, however, is the evidence in Chart 2 which points out
that nearly 70% of the annualized issuance since the beginning of QE II
has been purchased by the Fed, with the balance absorbed by those old
standbys – the Chinese, Japanese and other reserve surplus sovereigns.
Basically, the recent game plan is as simple as the Ohio State Buckeyes’
“three yards and a cloud of dust” in the 1960s. When applied to the
Treasury market it translates to this: The Treasury issues bonds and the
Fed buys them. What could be simpler, and who’s to worry? This Sammy
Scheme as I’ve described it in recent Outlooks is as foolproof
as Ponzi and Madoff until… until… well, until it isn’t. Because like at
the end of a typical chain letter, the legitimate corollary question is –
Who will buy Treasuries when the Fed doesn’t?

I don’t know. Reserve surplus sovereigns are likely good for their
standard $500 billion annually but the banks are now making loans
instead of buying Treasuries, and bond funds are not receiving generous
inflows like they were as late as November of 2010. Who’s left? Well,
let me not go too far. Temporary voids in demand are not exactly a buyers’ strike. Someone
will buy them, and we at PIMCO may even be among them. The question
really is at what yield and what are the price repercussions if the
adjustments are significant. Fed Vice Chairman Janet Yellen in a speech
just last week confirmed the theoretical rationale that Treasury yields
are directly linked to the outstanding quantity of longer-term assets in
the hands of the public. If that quantity is suddenly increased in one
year as the charts imply, what are the yield consequences? What I
would point out is that Treasury yields are perhaps 150 basis points or
1½% too low when viewed on a historical context and when compared with
expected nominal GDP growth of 5%.
This conclusion can
be validated with numerous examples: (1) 10-year Treasury yields, while
volatile, typically mimic nominal GDP growth and by that standard are
150 basis points too low, (2) real 5-year Treasury interest rates over a century’s
time have averaged 1½% and now rest at a negative 0.15%! (3) Fed funds
policy rates for the past 40 years have averaged 75 basis points less
than nominal GDP and now rest at 475 basis points under that historical
waterline.

As a counter, one would argue (and I would partially agree) that
the U.S. and indeed developed global economies must keep yields
artificially low for some time if post Lehman healing is to take place.
But that of course is the point. By eliminating QE II, the Fed would be
ripping a Band-Aid off a partially healed scab. Ouch! 
25 basis
point policy rates for an “extended period of time” may not be enough
to entice arbitrage Treasury buyers, nor bond fund asset allocators to
reenter a Treasury market at today’s artificially low yields. Yields may
have to go higher, maybe even much higher to attract buying interest.

Investors should view June 30th, 2011 not as political historians
view November 11th, 1918 (Armistice Day – a day of reconciliation and
healing) but more like June 6th, 1944 (D-Day – a day fraught with hope
for victory, but fueled with immediate uncertainty and fear as to what
would happen in the short term). Bond yields and stock prices are
resting on an artificial foundation of QE II credit that may or may not
lead to a successful private market handoff and stability in currency
and financial markets. 15% gratuities may lie ahead, but more than
likely there is a negative two-bit or even eight-bit tip lying on the
investment table. Like I did 45 years ago, PIMCO’s not sticking around
to see the waitress’s reaction.

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Liberty's picture

That's a silly question.  The Fed will buy the Treasuries of course!

Fish Gone Bad's picture

Our new found friend, Libya, will have 30 billion reasons to help buy our debt.

buzzsaw99's picture

The new Libyan gubbermint should pump out their oil as fast as they can and put all that "money" in the bank to watch it grow! LMAO!

Mad Max's picture

Yes, electronic entries of "money" in a "bank" are vastly more valuable than keeping on hand one of the world's most useful physical commodities.

66Sexy's picture

problem is, where does a declining dollar fit into all this? if the dollar drops it will prop up stocks and commodities, no matter who buys treasuries...

 

so.. could that be the end game?

hbjork1's picture

The end game will be to buy land, gold, silver or some other non perishable commodity.  Perserving buying power isn't easy.  I have a couple of fixed value pensions, one from 1972, one from 1986.  The 72 pension has been reduced in buying power by a factor of 6-8, depending upon how I measure it.  BUT, the country has relative stability and there has been much progress in things like health care and technical support for the routines of daily living. 

How many of those who read this have been on a cruse lately; easily affordable by a large segment of the population.  Air travel security was a pain in the neck but my last trip to LA took about 5 hours (From Detroit) and back less than that, coutersy of the jet stream.    A short (it seems) 50 years ago you would allow 2 to 3 days, depending upon how much rest you might want in between.  International travel today is very easy. 

The games that people play have always been there.  Corruption was alledged in the building of the Erie Canal.  Histories on the Union Pacific Railroad construction sometimes highlight the graft.  The California leg of that railroad used what ammounted to slave labor from China.  Los Angeles, that is in a semi-arid zone, grew with water stolen from the ranchers along the Colorado. 

There are now 300+ million people in the country.  Even if it must be done as a share holder, the long term inflationary defense holding is productive farm land.  Effective yields are low ~1-4% through the years. And it may take a few years to recover transition costs but value is not transient.

High Plains Drifter's picture

Chairsatan, I love it. That's about right....

 

Now after all of this time, who among you can argue that this is not being done on purpose, the destruction of the United States as we have known it , right before your eyes.

Judge Judy Scheinlok's picture

I have search for an answer to that question ad nauseam.

When the 30 yr bonds mature where is the money going to come from to pay back the principle?

Just curious....

Max Hunter's picture

Correct. They have to. Any foreigner that does is a fool.. And are we to expect that over 10% of our GDP is to be borrowed for the government to spend us out of a recession/depression? How absurd. Prepare accordingly. I'm hoping for another email from my favorite ammunition site to drop another grand on ammo and clips..

Chump's picture

Someone posted this on another article.  It gave me some ideas.

http://www.thepowerhour.com/news/items_disappearfirst.htm

 

grey7beard's picture

>> Prepare accordingly. I'm hoping for another email from my favorite ammunition site to drop another grand on ammo and clips..

So, how much have you put into medical supplies, or are you expecting incoming lead to pass harmlessly through your Terminator like body?

Mad Max's picture

It's only harmless if you're a T1000.  Any earlier model and it's a major nuisance, or worse.

Max Hunter's picture

So, how much have you put into medical supplies, or are you expecting incoming lead to pass harmlessly through your Terminator like body?

Good one smartass.. Actually, guns and ammo are only a portion of what i've done to prepare for chaos or possible emergency. They can also be used for barter. So, the answer is yes, medical supplies along with food, water, fuel and a host of other things that would allow me to stay indoors and need nothing from stores while many other are scrambling for basic necessities.

It appears your wisdom alone will be enough to sustain you and your family if our everyday lives are interrupted with an emergency. Good luck with that.

Bob's picture

It has to be scary indeed to have kids and a house in an urban area when you contemplate armageddon. 

At times like those, being a renter who is foot loose and fancy free with a rural destination at a reasonable distance is a luxury that few can afford otherwise. 

grey7beard's picture

>> It appears your wisdom alone will be enough to sustain you and your family if our everyday lives are interrupted with an emergency.

Oh, I've liquidated my city holdings and moved to a bit of rural acerage.  I've a nice off grid cabin to go along with the house on the propety.  My assets as well protected as one can probably be, considering the future is not clear.

I just find the Rambo types pounding their chests about buying "another" thousand dollars worth of ammo and clips to be humorus.  Never do you hear of anyone bragging about their stores of medical supplies and other not so glamours necessities.  I'd say if the lead starts flying the average Rambo wanna-be's life expectency is going to less than one six round clip.  And bartering bullets?  Hehe, cute.

Doubleguns's picture

Yes, yes Benny Madoff of the Bernanke will continue to print money to buy the bonds to create the jobs to restore the economy to make us all wealthy.  Then QE3 will makes us wealthier along with QE4 and so it goes. There is no ponzi scheme here. We are all going to be rich. 

Oh regional Indian's picture

Not the PimpleCo blowhard who just got religion, again!

This is not looking good at all. The jawboning that is.

Orchestrated end to musical chairs.

Last one get's to buy and hold the exploding Sack.

JUMP!

ORI

http://aadivaahan.wordpress.com/2011/03/01/on-outsourcing-and-its-ills/

wisefool's picture

Yup. In the same boat of rats you got buffet telling CNBC this morning that

 

  • paper money is a terrible investment
  • Governments are a terrible investment
    • New government employees must not be given the same compensation as current ones. (mine:) Anybody who understands large organizational dynamics knows that junior people will not work hard for senior people if there is a chasim in incentive models for time on task.
  • The GSE garentees made finance essential free for underqualified banks and the borrowers on the edge (speculators)
  • Me and my peers could give our money to the government instead of overpaid, tax free, feel good charities. But I dont want to. A "voluntary" tax system is probably not the best one.

 

 

Standard generational "I got mine, eat some cake" from both Buffet and Gross.

 

Oh regional Indian's picture

Very interesting eh, Wisefool? A full court press on "Hate the System".

Gross Buffet: One bite and then you throw up.

ORI

wisefool's picture

Well Buffet also said, "don't worry, the cake/pie will get bigger. when I was born people could have thought the stockmarket would have gone down 75%, but the american people succeded. I mean we built battleships, we will make alot of cars in 2020, we just have to decide who is going to get them. I mean if you look at the tax forms for the top 400 people over any period of recent time, thier rates consistantly go down"

And then he says, "I never bought a share of bank of america personally" followed by the already mentioned: (sarc/para) I don't want to give my money to the goverment, the same one that funded my entire existance, including daddy's pension and connections.

Oh regional Indian's picture

All these liars must be having to get their noses trimmed everyday.

No wonder plastic surgery is still thriving. The hubris and the delusion is stunning.

ORI

Bob's picture

My favorite nugget from Uncle Warren this morning was "excess US housing inventory will be cleared within 12 months." 

Wow. 

Trundle's picture

Young people will eat senior/old people if the incentives are right.

Humidifier yields paella.

Freeze-drying soylent green.

SheepDog-One's picture

Theyre all scrambling for a chair, and all the chairs are covered in poop.

DaveyJones's picture

who bought Yugos?

aurora lancelot's picture

I got one 10,000,000,000.00 Yugoslavian Dinar bill.  I bought it on a flee market and paid 40 Euros for it.

ceilidh_trail's picture

Ha Ha sucker- I did better than you!!! I bought a 100 trillion dollar zimbabwe note for only 5 bucks (us)!!! Guess I'm the big wheeler dealer around here...  <sarc>                     By the way, where's harry wanger these days?

Cash_is_Trash's picture

Ben shall monetize our problems away.

Like IceCap pointed out:

The con therefore is to keep short-term rates as close to zero as possible, while printing money to keep longer-term interest rates as low as possible.

We're in for a bushwhacking

Mad Max's picture

What does PIMCO put their money in if it's not US treasury bonds or stocks?  It's not like you can get a meaningfully insured bank account for the figures they're dealing with.  Does this mean they'll be going into commodities?  Chinese bonds?  Farmland in third world countries?  Their assets don't exist unless they're parked in something.

kalum's picture

Like you, I NEED to know, Where, where where?

Mad Max's picture

After posting my first comment, I started wondering if this statement could just be a threat used in bargaining to get the Fed to raise interest rates to a level at which PIMCO wants to buy, with the possibility of triggering a debt crisis as the hammer.  Since I'm still puzzled at what other investments could make sense with PIMCO's asset base and focus, this is what I'm leaning toward.  Any other market that PIMCO goes into will be distorted and driven up by the size of the funds involved.  Although most of us commenters would make out well if they decided to pull out of FRNs and go into gold/silver - which would probably make Zimbabwe's currency collapse look glacial in comparison to what that move would trigger for FRNs.

SilverBaron's picture

The ultimate asset.  Human capital. (slaves)

What would the going rate be?  50 cents an hour in China.

I am a Man I am Forty's picture

lately mexico and brazilian bonds with more yield, among other places

Meme Iamfurst's picture

a few months back, Mr. Bill bought a Brazilian landfill dump size position of crap mortgages from the Fed at a discount to what the Fed paid ( gosh, what a surprise). 

The kicker here is that ol' Bill did it on margin as i read here on ZH, less than 25% down payment.  Now Bill had the assurance of 'those in the know' that these mortgages would be worth more than he 'paid' and generalte a much needed yield.   Annnnn, wrong answer, they are underwater and thus his leverage is in need of a Australian sized band-aid.  He ain't been happy with ol'Ben B ever since, and has been dishing Benny like a jilted girl friend.

spartan117's picture

Pimco just issued a "sell" rating on everything.

 

Sell everything and convert to what?   Dollars?  Surely, you can't be serious.

Mad Max's picture

Even if they could convert it all into dollars - how?  Are you talking mountains of paper Federal Reserve Notes, bearing no interest and with theft risk?  Or an electronic entry in some bank?  Insuring one depositor for $250k is one thing, insuring one for $100B - c'mon, the only entity that could (maybe) do that is the US federal government, which they just declared is not their preferred credit risk.

As I noted above, I don't even see how they get out of the standard investments in light of the asset base they have.

SheepDog-One's picture

Convert to firearms, ammo, and food stockpiles, or die. And dont call me Shirley.

ivana's picture

USD could be one of scenarios before whole ponzi collapses. Interest rates aprox 15% and USD high high much higher than today... wouldn't you buy?

And how to get worthless USD so high? Just ask "utility magicians"...

spartan117's picture

Interest rates at 15% would mean 100% of the Treasury's revenue would be diverted to paying interest on existing debt.  That's armageddon for the USA.

I wouldn't take USD if it were given to me at that point.

ivana's picture

How about bond buy back from "friendly bond buyers"? So there's general lack of USD liquidity, generaly repatriation, oil very high etc etc ... fin armageddon generaly.

And satan still has power to print and he still have "friends" who need USD cash - so buy back for 20% of original debt?

+ under desk favors for "friends"

John Wilmot's picture

Exactly right. The Fed has but two choices: monetize treasuries ad infinitum and stoke hyperinflation, or stop monetizing treasuries, allow Treasury to default, and then experience hyperinflation as the dollars abroad repatriate and the ones at home are dumped by everyone en masse.

Even if Congress balanced the budget, there's still a tremendous amount of old debt to roll over all the time, and in order to fund that through real investment, rates would have to rise so much that I think they'd find themselves right back where they started, with massive deficits and Fed funding. And it is clear that the IMF/World Bank and BRICS are actively preparing for a post-dollar international monetary system - game's over. King Dollar's at the flee Paris stage, soon to be hauled back, placed under house arrest, tried, and guillotined. Then comes the Terror...and later, the new consul-for-life.

bs's picture

Sure I can... And don't call me Shirley!

potatomafia's picture

If this does not indicate a treasury bubble, i dont know what does.  The debt market is so large people cant even fathom what to do without it!  and its a good point.  They will have to get into things, assets.. 

 

The treasury market is the only thing preventing hyperinflation, no? 

MsCreant's picture

And money locked up in the derrivatives market?

potatomafia's picture

I dont know much about that, other than it is huge.. 

 

Are you saying that the derrivatives market could absorb the money leaving treasuries?  or are you saying that the money would not only flow out of treasuries, but also out of the dirrivatives market?

 

I think you are implying that it would also flow out, and increase prices even further..

MsCreant's picture

Money locked in the derrivatives market may also be preventing hyperinflation. I may be wrong though. If they blow up, that is a deflation bomb (can the default insurance really pay off if the margin call from hell rings across the globe? NO!). But it is "value" that is parked. I am no expert, but my brain, like yours, likes to play here on this site.

Your supposition was a creative one.