Tuesday, December 18, 2007

Pimco's Gross Says U.S. Headed for `Mild' Recession (Update2)

By Kathleen Hays and Daniel Kruger

Dec. 18 (Bloomberg) -- Bill Gross, manager of the world's biggest bond fund, said the U.S. is headed for a ``mild'' recession in 2008 amid the worst housing slump in 16 years.

The economic contraction will be ``a mild one based upon housing and its ultimate handoff, I suppose, to the consumer,'' Gross said in an interview on Bloomberg Television. The U.S. economy will grow as little as 1 percent on average next year, he said.

Most analysts are more bullish on the economy than Gross. The economy will grow at a 2.3 percent rate on average next year, according to the median forecast of 62 analysts surveyed by Bloomberg from Dec. 3 to Dec. 10.

Gross reiterated his forecast that the Federal Reserve will have to keep lowering interest rates, after three cuts since Sept. 18, bringing the overnight benchmark rate to 4.25 percent.

Tomorrow's release of the results of the Fed's auction of $20 billion in 28-day funds will be a gauge of how much further the central bank needs to lower borrowing costs, he said. The Fed on Dec. 12 said it planned four such auctions to add cash to the banking system.

``You want to look at the amount that was bid for,'' he said. Should that tally reach $50 billion to $100 billion or more, ``that's a sign that conditions are tight.''

Auction Rate

At the same time, the higher the rate is that the banks offer for the loans, the greater the sign of distress in the financial system, Gross said. The minimum accepted bid set by the Fed was 4.17 percent.

Should the rate approach 4.75 percent, which is the level banks can borrow at directly from the Fed, it's a ``sign that in the United States we've got real liquidity problems,'' Gross said. The Fed cut its discount rate, as that direct lending rate is called, by a quarter-percentage point to 4.75 percent on Dec. 11.

Pimco, a unit of Munich-based insurer Allianz SE, manages about $721 billion.

Gross's $108 billion Total Return Fund has returned 7.43 percent this year through yesterday, according to Morningstar, the Chicago-based research firm. That return is ninth-best among the 352 distinct portfolios, excluding multiple share-classes, in the intermediate bond fund category, according to Morningstar. The average return for the group this year is 3.72 percent.

`Value' in Mortgages

The fund held 47 percent of its assets, weighted by duration, in mortgage-related debt as of Sept. 30, its largest concentration, according to Pimco's Web site. Debt maturing in less than a year accounted for 41 percent of assets. Bonds with a longer duration tend to be more sensitive in price to changing interest rates than shorter-duration securities.

Mortgage-backed securities guaranteed by government- chartered companies such as Fannie Mae and Freddie Mac ``offer very compelling value,'' Gross said yesterday in an interview posted on the firm's Web site.

The difference between the yield of 10-year Treasury notes and the 30-year current coupon Fannie Mae bond widened to 1.76 percentage point on Nov. 20, the most since January 2001, according to data compiled by Bloomberg.

In May Gross said he had made a ``mistake'' in the previous 12 months forecasting the Fed wouldn't lift rates as high as 5.25 percent, as the central bank did, and then again in predicting in October 2006 that the Fed would start cutting borrowing costs in the first half of this year.

To contact the reporter on this story: Kathleen Hays in New York at Khays4@bloomberg.net ; Daniel Kruger in New York at dkruger1@bloomberg.net

Last Updated: December 18, 2007 16:12 EST

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