June 5, 2014 / 1:20 PM / 4 years ago

UPDATE 2-Pimco's Gross sees 'New Neutral' real policy rate close to 0 pct

(Adds Pimco Total Return Fund’s asset allocation exposures; quotes)

By Jennifer Ablan

June 5 (Reuters) - Bill Gross, manager of the world’s largest bond fund at Pimco, said Thursday the firm believes the ‘new neutral’ inflation-adjusted federal funds 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, which manages $1.94 trillion in assets, introduced its new-neutral outlook in May. New Neutral suggests the global economy is transforming from a post-financial crisis recovery period called the New Normal in 2009, toward stability 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. The collapse of Wall Street firm Lehman Brothers in 2008 sent the financial crisis into high gear.

“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 before the financial crisis, central banks all around the world are likely to keep key interest rates low, cushioning lending rates from a sharp rise.

On 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 anchored near zero, with many economists expecting it to begin rising in mid-2015.

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.

As of April 30, Gross’ Pimco Total Return Fund, which has $229 billion in assets, held 41 percent of them in U.S. government-related securities, 19 percent in mortgage assets and 12 percent in U.S. credit.

Gross, who has used his investment letters as a platform for his views on life, said on Thursday that our modern age is becoming more virtual than physical, “which I find increasingly depressing if only because I’ve failed to keep pace. I don’t even own a cellphone.”

He said: “My view is that there is time stored in that cellphone but its vintage may be somewhat sour, as compared to the sweetness of the here and now. The most unfortunate aspect of this new virtual reality stored deep within ”inner space“ is that more and more people, especially young people, are evolving to believe that these experiences are ‘natural.'”

Reporting by Jennifer Ablan; Editing by Chizu Nomiyama, Nick Zieminski and Richard Chang

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