Bill Gross, manager of the world's largest bond fund at Pimco, said Thursday the firm believes the 'new neutral' real, or inflation-adjusted, policy rate will be close to 0 percent as opposed to 2-3 percent in prior decades.
"If 'The New Neutral' rates stay low, it supports current prices of financial assets," Gross said in his latest investment letter. "They would appear to be less bubbly."
Pacific Investment Management Co, with assets under management of $1.94 trillion, first introduced its new-neutral outlook in May. 'New Neutral' suggests the global economy is transforming from a period of recovery after the financial crisis — termed the 'New Normal' back in 2009 — toward stability that is characterized by modest economic growth over the next three-to-five years.
"Commonsensically it seems to me that the more finance-based and highly levered an economy is the lower and lower real yield levels must be in order to prevent a Lehman-like earthquake," Gross said in Thursday's letter to clients, which is posted on Pimco's Web site.
"If the price of money is the basis for an economy's prosperity – and it is increasingly so in developed global economies – then central banks must lower the cost of money to maintain that prosperity – and keep it low."
With economies expanding more slowly than they did prior to the financial crisis, central banks all around the world are likely to keep their key interest rates low, cushioning lending rates from a sharp rise.
Thursday, the European Central Bank cut interest rates to record lows, imposing negative rates on its overnight depositors to cajole banks into lending more and to fight off the risk of deflation. In the United States, the fed funds rate is currently anchored near zero, with many traders and economists expecting it to begin rising in the middle of next year.
But Gross suggested yields will be dictated by how high the Fed eventually hikes rates and that the 'New Neutral' suggests that "the real policy rates will be frigidly low for an extended period of time." Consequently, yields across the credit markets may stop at a lower point than in past rate cycles.