Feb. 3 (Bloomberg) -- Bill Gross, who runs the world's biggest bond fund at Pacific Investment Management Co., said the U.S. debt burden may cause economic growth to falter once the Federal Reserve starts to raise interest rates. ``When and if interest rates do go up, the servicing costs of an accelerating debt economy eventually bite the hand of its master,'' Gross wrote in a monthly commentary published on Pimco's Web site. ``Borrowers will pay more in real terms, affecting consumption, home building and buying, business investing, and government deficits alike.'' The Treasury will probably say tomorrow it's going to sell $58 billion of notes next week, according to five of the firms, or primary dealers, that trade with the Fed's New York branch. The U.S. plans to borrow a net $177 billion from January to March, the most in a quarter, to finance a record budget deficit.
The borrowing will help the U.S. to plug a shortfall that the White House yesterday said would grow to $521 billion this fiscal year. Massachusetts Senator John Kerry and other Democrats trying to oust President George W. Bush have helped make the deficit a campaign issue for the November presidential elections.
`Mars and Beyond'
``$500 billion may only be a start if in fact we're going to the Moon, Mars, and beyond,'' Newport Beach, California-based Gross said. He runs the Total Return Fund at Pimco, which is owned by Allianz AG, Europe's biggest insurer. The $74 billion fund returned 5.9 percent in the past year, according to Bloomberg data. Gross has been advocating buying Treasury inflation-protected securities, or TIPS, and other assets that benefit from increases in prices such as commodities and real estate. Pimco Total Return Fund invested almost a quarter of its assets in Fannie Mae debt securities at the end of last September, a regulatory filing shows. Pimco Total Return bought the debt securities in mid-2003 as yields on Fannie Mae debt rose amid questions about the oversight of Fannie Mae and Freddie Mac, the two government-chartered companies that own or guarantee about 42 percent of U.S. home mortgages.
Fannie Mae Holdings
As of Sept. 30, Pimco Total Return held $17.8 billion of Fannie Mae debt securities that matured in six months or less and bore interest at rates ranging from 1 percent to 1.15 percent, according to a shareholder report filed with the U.S. Securities and Exchange Commission. Bush administration officials say that deficits stem from higher spending for the war in Iraq and domestic security, a recession that began and ended in 2001, and $1.7 trillion in tax cuts that Treasury Secretary John Snow credits with keeping the economic contraction short lived. Kerry, who won his party's Iowa caucus and New Hampshire primaries, has pledged to repeal the Bush tax cuts that contributed to the wider budget shortfall. As the budget deficit swelled, the Bush administration has sold notes more frequently, and added three-year Treasuries to its quarterly sales of five- and 10-year notes. The Treasury may also say tomorrow it will introduce a 20-year inflation-linked bond, analysts at five of the 23 primary dealers said.
Borrowing Increases
The forecast $58 billion in sales this quarter would be $1 billion more than in the three months to December, and compare with a record $60 billion for the third quarter sold in August. Fed chairman Alan Greenspan has kept the target rate on overnight loans between banks at 1 percent, the lowest since 1958, since June. The yield on the Treasury's benchmark 4 1/4 percent note due November 2013 on Jan. 23 fell to a three-and-a- half month low of 3.92 percent, and was at 4.11 percent at 9:42 a.m. in London. ``Whoever is at fault -- whether it's Pimco for buying it or Greenspan for blessing it, or Wall Street for pushing it -- we are at a point where there's a lot of it,'' Gross said. ``That point no one can deny.''
``We are hooked on debt; we are a finance-based economy,'' according to Gross. Because such an economy ``depends on more and more low cost money in order to thrive, the game ends'' when interest rates rise. Gross told financial news network CNBC on Thursday that the Fed may raise the key rate as early as the third quarter. The Fed on Wednesday changed the wording of its policy statement to say it can be ``patient'' before increasing the key rate, after stating it would wait ``for a considerable period'' previously. ``The timing of the increase and the amount to which they gravitate is still a question, but I think the timing is a little bit closer,'' Gross said in the televised interview with CNBC. The U.S. economy will grow 4.4 percent this year, according to assumptions in the White House's fiscal 2005 budget. Gross domestic product grew a less-than-expected 4 percent annual pace in the last quarter of 2003.
The economic situation is not one ``where you can afford to risk bludgeoning the economy with sharply higher interest rates,'' Gross said in his monthly commentary. //www.bloomberg.com