Bill Gross – January 2013 Investment Outlook: Seesaw Rider

I am amazed at the fascination and emphasis placed on the u-rate during employment Fridays. Bond prices will move (in some cases by points) with a minor up or down change in unemployment relative to expectations, but when it comes to the third little pig of the litter – inflation – no one seems to care. This number – the PCE annualized inflation rate – is released near the 20th of every month but you will not see CNBC or Bloomberg analysts waiting with bated breath for its release. I do. I consider it the critical monthly statistic for analyzing Fed policy in 2014. Why? Bernanke, Yellen and their merry band of Fed governors and regional presidents have told us so. No policy rate hike until both unemployment and inflation thresholds have been breached and even then “they’re not thresholds,” they’re forks in the road that may or may not lead in a different direction. (To paraphrase Yogi Berra, “if you come to a fork in the road, you don’t have to take it!”) At the moment, the Fed’s fork or target for PCE inflation is 2.0% or higher while December’s annualized rate was only 1.2%. Miles to go before Yogi or anyone else has to begin worrying about a policy rate hike. 2016 at the earliest.

If so, then 1-5 year bonds, combined with credit, volatility, curve rolldown, and a dollop of currency should float a bond investor’s boat in 2014 and avoid breaking the buck in total return space. I’m not saying we’ve got a bull market here. That would be like saying the Knicks or the Cubs have got a chance to win the big one. They don’t, and a bull market in bonds is one for the history books. But if PCE inflation stays below 2.0% and inflationary expectations don’t rise appreciably above 2.5%, then a 3-4% total return for 2014 is realistic. Granted, that doesn’t come close to the 11% yields that my mother grew used to years ago, but then she was riding a seesaw and never knew it. Bond investors will be less rich, but more placid in 2014 than when she was teetering and tottering her way to good fortune.