Monday, March 10, 2014

Disregard;PIMCO's Gross tweets: "Sell what the Fed has been buying...

PIMCO's Gross tweets: "Sell what the Fed has been buying because they won't be buying them when Taper ends in Oct."           
More importantly, the Fed won't be selling what they have purchased.  The maintenance (lack of selling from) of the Fed balance sheet will help to support the long end of the U.S. Treasury curve.  However, even though the Fed would like otherwise, as the purchase program comes to an end, widely expected in October of this year, economic agents will test the current forward guidance understanding of the lift-off date.  Because each passing day means less of the 5yr Treasury is covered by ZIRP, we should expect a build-up of pressure on rates in the belly of the curve as the purchase program comes to an end.  The 5yr has been the mainstay for PIMCO and has not kept the shop in good stead over the last year.  Unless they jettison the notion that 5yr is the place to be, they will continue to under-perform their peers. 

The Treasury 5yr-30yr yield curve spread is at 210 basis points wide today.  Based on US$ swaps, the forward curve suggests the 5-30 yield curve spread will not flatten to 120 basis points until roughly September 2015.  Instead, I think this spread can narrow below 120 bps much sooner than this and likely within a year from now.   

The above reflects the expectation that above trend growth is evidenced in the second half of this year and there is ample reason to expect this to happen.  Generally speaking, an inventory build into the early part of Q4 2013 combined with the fiscal folly of budgetary wrangling kept corporate managers from hiring or building out capacity.  A growing interest in build-out and modernization of production facilities will prompt a move from exaggerated dividend pay-out and equity share buybacks to a renewed focus on capital improvements.  These factors will help to drive H2 growth beyond 3.5% and possibly as high as 4.25%. 

If the above economic growth path is achieved, the expectation for policy rate lift-off date will shift up the curve and the 5y treasury will suffer while the yield curve will flatten given greater assurances that the Fed will be holding its portfolio to maturity.   

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