As time goes by, Bill Gross' letters have become increasingly more bizarre, and at times morbid, and his latest monthly note is no exception.
It begins with a flashback to the days of wars, both real and fictional, and Gross' musings if indeed, as many believe, society is becoming more civilized or if we are merely internalizing all of the "murderous beastly" passions that always seem to spill over in some isolated or mass murderous event. As he makes it quite clear, the legendary bond-trading billionaire is skeptical:
Some say humanity is making progress, and that civilization is becoming more "civilized", but I wonder. Optimists would point to the global political focus on human rights and the slow, although sporadic, steps forward on racial and gender equality, but these are social morés generally unrelated to humankind's tolerance for evil on a grander scale. "Thou shalt not kill" is a commandment on Moses' tablet for a good reason, and yet our killing of each other in mass quantities continues unabated. Stalin and Hitler's atrocities seem perhaps long ago to younger generations, but then the "killing fields" of Pol Pot, the millions of lost souls in the Middle East, and the ongoing tribal carnage in parts of Africa testify to the "evildoing" of governments or religious factions in defense of Fascism, Communism and yes – Democracy. "God", it seems, wears numerous hats, but almost always in defense of one particular ideology or another. "God Bless America"? Yes hopefully – but why not Cuba or the Congo? Chauvinistic mantras can be bonding but also destructive when used to kill masses of people for specious reasons. America – the self-proclaimed defender of freedom and equal rights – has proved vulnerable to those ideals in Vietnam, Iraq, and now Afghanistan and elsewhere.
Careful Bill, thoughts like those would be sufficient to brand you a Russian operative by the rabid "Resistance" which sees the KGB's finger any time someone dares to criticize either the US or the grand "neoliberal" order.
Then again, at age 73, Gross is probably not too worried if he will spend the rest of his days in prison following a ruling by some Marxist "people's court", instead he looks inside to unveil the "beast" that prompted him to become a "killer" for a cause not that long ago:
Having participated in one of those wars, I suppose I should look inward and question my own behavior when I was the age of 22, or even now at 73. I often do. I guess in part, that is why I question humanity's progress. If I was a willing killer then, how can I expect others and their governments to not do the same? I can't, but it's important for all of us to try to understand why humanity evolves slowly, if at all. For me, William Golding in his brilliant "Lord of the Flies" expressed it best. Searching for a murderous "beast" on a deserted island, a previously innocent group of young boys began to kill each other to ensure their own survival. "Maybe there is a beast", said one child, "but then maybe it's only us." Maybe it is us. Maybe we haven't evolved. Hopefully future robots can be programmed with a better understanding of Moses' commandment, so that when they take over, we will have a more civilized society.
Robots maybe... but what about central banks?
Because this long preamble by the Janus Henderson Unconstrained Bond Fund manager is just a way for Gross to get to the punchline of his note, something we have repeatedly pointed out here, and which boils down to the following: there is just too much debt in the world to allow rates to rise too high, or as Gross puts it:
The U.S. and global economies are too highly leveraged to stand more than a 2% Fed Funds level in a 2% inflationary world
Which is why Gross warned that "if more than 2 percent, a stronger dollar would affect emerging market growth and lead to perhaps premature tightening on the part of the ECB and other developed market central banks" and adds that, "the Fed's purported 3 to 4 hikes this year beginning in March are likely exaggerated." But where's the best? Well, it's shown in the chart below, and represents a record $233 trillion in global debt.
So in hopes of avoiding a confrontation with the "beast", Gross next lays out his hope that Powell will keep the tightening cycle gradual and 'proceed cautiously':
When it comes to financial markets, (both bond and stock) the "beast" is really leverage, and while it's hard to pinpoint when enough is really enough, the Great Recession really informed us that Hyman Minsky was right – "stability leads to instability" as good times and higher prices lead to a false sense of optimism. The Fed, under Jerome Powell, hopefully has learned that lesson, and should proceed cautiously, as must his counterparts around the globe.
Perhaps he has learned that "lesson"; however as we first pointed out three months ago, Powell also has learned something else: the Fed has created the world's biggest asset bubble and - with its policies - is actively encouraging it.
I think we are actually at a point of encouraging risk-taking, and that should give us pause. Investors really do understand now that we will be there to prevent serious losses. It is not that it is easy for them to make money but that they have every incentive to take more risk, and they are doing so. Meanwhile, we look like we are blowing a fixed-income duration bubble right across the credit spectrum that will result in big losses when rates come up down the road. You can almost say that that is our strategy.
As for the upcoming showdown between central banks and the "beast" which they themselves created, that leaves Gross skeptical that assets will survive.
I write this – not in support of low interest rates and financial repression – indeed I have argued for the necessity of an eventual normal rebalancing if small savers and financial institutions such as pension funds and insurance companies are to continue to perform their critical capitalistic role.
In practical terms, this means that Gross believes that after just 2 more hikes the Fed will be done:
I believe, as does Fed Governor Neel Kashkari, that our financial systems' excesses cannot be expunged quickly by "liquidating assets" à la Andrew Mellon in the 1930's, but by a mild and gradual re-entry back to privately influenced, as opposed to central bank suppressed, interest rates. 2% Fed Funds in a 2% inflationary world is the current limit in my opinion.
As a result, Gross' conclusion is a somewhat contradictory take on his previous call for a bond bear market - he now sees the 10Y trading where it is as the great "global bond bear market" goes back into hibernation... if only for the time being:
Investors should therefore look for 3% plus or minus on the 10-year for the balance of 2018. That level should ultimately force German Bunds and UK Gilts to higher yields, perhaps 1% on Bunds and 1.75% on Gilts. Still, in my mind, this is a hibernating global bear bond market, not a beast. That may come later, much like our programmable robots that may control future society.
To be sure, between a race of despotic robotic overlords, and a 10Y in the double digits, which would send the S&P back into the triple digits, it is unclear which option our current Wall Street leaders would choose.