PIMCO: Fed won't increase interest rates until 2011
Don't look for the U.S Federal Reserve to increase short-term interest rates anytime soon. Paul McCulley, managing director of PIMCO, the world's largest bond fund, said the Fed won't increase borrowing costs before 2011, due to the threat of deflation.
Key short-term interest rates will not rise "before 2011 and I'm not only forecasting that as a professional forecaster, but positioning portfolios on that proposition as well," McCulley said in an interview with Australian Broadcasting Corp., Bloomberg News reported Monday. "What I'm worried most about is simply a shortfall in global aggregate demand relative to supply potential."
McCulley, who heads PIMCO's short-term bond desk, spoke before the release of Q2 U.S. GDP data that indicated the nation's worst economic slump in more than 20 years appeared to be bottoming. U.S. GDP contracted a less-than-expected 1 percent in Q2, after a 6.4 percent plunge in Q1.
The comments are also in-step with McCulley's PIMCO colleague, bond guru Bill Gross, who manages PIMCO's Total Return Fund. In his August investment letter, Gross said U.S. economic growth will be closer to three percent than the five to seven percent range recorded for the past 15 years, adding that he expects the economy to begin to recover in the second half of 2009.
Inflation hawks have it wrong
Further, McCulley said the inflation hawks, concerned about rising U.S. inflation amid record Fed intervention to provide liquidity to credit markets and support institutions whose failure would pose systemic risk, have misplaced their concern. McCulley said he was concerned about a protectionist backlash, downward pressure on wages, and economic nationalism replacing multilateral cooperation in monetary and fiscal policy.
"It's difficult to see where private sector aggregate demand is going to come through as the world is delevering and trying to increase its savings rate," McCulley said, Bloomberg News reported. "A global economy that is chronically operating under its potential with idle resources, that creates social implications that are unjust and at worst destabilizing."
The United States has added more than $10 trillion in monetary liquidity to the financial system. That monetary stimulus is essential because credit markets comprise the lifeblood of the economy. Businesses large and small access short-term credit to meet payrolls, pay suppliers, and access cash for other short-term needs. Banks also lend to one another to meet short-term cash needs. A market-based economy can not operate at its growth potential without liquid, functioning credit markets, most economists agree.
Economic Analysis: McCulley, in no uncertain terms, reiterates that the biggest risk for the U.S. economy is not inflation, but deflation, stemming from a lack of demand. Deflation - a protracted, systematic decline in prices and wages - occurs in pronounced recessions and other conditions in which demand is weak. Robbing companies of the ability to increase revenue, it handicaps the economy's ability to grow. If it takes hold, deflation can lead to the dreaded 'deflationary spiral,' in which price cuts lead to lower corporate revenue, prompting more lay-offs, leading to further consumer spending declines, prompting more price cuts, and so on. That has to be avoided, and if it means the Fed won't increase rates until 2011, that's the stance the Fed should take.