Bullard Kills The Mood, But Gross Says Fed Easing 'A Done Deal'

Although St. Louis Fed President James Bullard poured cold water on the bulls’ hopes yesterday that the Fed would initiate a third round of quantitative easing at next month’s FOMC meeting, PIMCO’s Bill Gross, the manager of the largest bond fund in the world, said Thursday that a Fed easing is a “done deal.”

While the stock market was looking like it was ready to embark on a corrective phase earlier in the week, the indices came roaring back Wednesday after the minutes from the latest FOMC meeting suggested that the Federal Reserve was likely to deliver another round of monetary stimulus (aka quantitative easing or “QE”) "fairly soon".

The key line from the FOMC minutes that seemed to grab traders’ attention stated, "Many members judged that additional monetary accommodation would likely be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery."

Stocks rebounded off their intraday lows in reaction as the prospect of additional monetary stimulus from Ben Bernanke’s Fed meant that the risk trade should be switched to the “on” position.

However, Bullard, who is not a voting member of the FOMC, effectively raised doubts about what the Fed would do next on Thursday.

Acting as a guest host on CNBC’s “Squawk Box” program Thursday, St. Louis Fed President James Bullard played down the belief that the FOMC minutes released Wednesday suggest the central bank is inclined to act soon to stimulate the economy. Those minutes, Mr. Bullard said, are “a bit stale.” Bullard added that he doesn’t believe U.S. data now warrant a “gigantic” policy response by the Fed.

The WSJ summarized Bullard’s comments as follows: The probability of further stimulus from the Fed is “not as high” as expectations seen this summer in the financial markets, Bullard said. Still, he said he might support a more modest response if data turn soft, and that the central bank has that option on the table. In response to U.S. initial jobless claims data, released Thursday and which showed a rise of 4,000 to 372,000, Mr. Bullard said he doesn’t get concerned unless the indicator rises about 400,000.

The market reaction to Bullard’s comments was rather swift as European stocks and U.S. futures fell immediately following the St. Louis Fed President’s early morning remarks. And traders followed up with additional selling once the opening bell rang.

But PIMCO’s Gross, a long-time Fed watcher, thinks there was one phrase used in the FOMC minutes that makes the Fed’s intentions perfectly clear.

“What the Fed minutes told us is additional easing might be warranted ‘fairly soon’ unless the incoming data pointed to a sustainable strengthening of the economy,” Gross said. Gross believes that the "sustainable strengthening" language is important. “I think we need to see months of 3 percent or better gross domestic product growth before the Fed backs off that particular provision,” he added.

Gross thinks that when the Fed does take action (a question of when not if according to the PIMCO founder), it will utilize “a relative open-ended program in terms of size, in terms of time and in terms of what the asset classes is they buy.” Gross added that being open-ended will give the Fed the flexibility to modify their posture "even in the face of a strengthening economy."

In terms of how to play the anticipated move by the FOMC, Gross continued to suggest that investors “shake hands with the government.” Gross said you want to “buy what the Fed is going to buy and buy what the Fed is going to affect.”

Gross added that Treasury Inflation-Protected Securities (TIP) and mortgages (MBS) are the beneficiaries of what is expected to be the Fed’s approach.

In addition, should the Fed announce their intentions to start buying debt securities on the open market again (aka QE3) the “risk on” trade would be put into play by traders and hedge funds everywhere.

For those looking to jump on board the “risk on” train, the following ETF’s have participated nicely in the past: U.S. Stocks (SPY, SSO, UPRO), Emerging Markets (EEM), Commodity Indices (DBC), Gold (GLD), Silver (SLV), Copper (JJC), and Junk Bonds (JNK). Or one could simply utilize the “risk on” ETF from ETRACS, symbol ONN.

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