Bill Gross: QE2 Signals End of Bond Rally

NEW YORK (TheStreet) -- The Fed's announcement of quantitative easing, widely expected next week, would likely signify the end of a great 30-year bull market in bonds, according to Pimco chief investment officer Bill Gross.

In his November outlook, the influential bond fund manager said that Pimco largely endorsed the Fed's move but admitted that he was uncertain of whether further quantitative easing will help the economy.

"We are, as even some Fed Governors now publicly admit, in a 'liquidity trap,' where interest rates or trillions in QE2 asset purchases may not stimulate borrowing or lending because consumer demand is just not there. Escaping from a liquidity trap may be impossible, much like light trapped in a black hole. Just ask Japan. Ben Bernanke, however, will try -- it is, to be honest, all he can do," he wrote.

Vote: Will QE2 Work?

On the outlook for bonds, however, Gross was decidedly less bullish. "While next Wednesday's announcement will carry our qualified endorsement, I must admit it may be similar to a turkey looking forward to a Thanksgiving Day celebration," he wrote.

"Check writing in the trillions is not a bondholder's friend; it is in fact inflationary, and, if truth be told, somewhat of a Ponzi scheme," Gross wrote. Further quantitative easing would only temporarily raise prices giving the illusion of high returns, but ultimately prices will reach a dead-end as interest rates head to zero bound. "Having arrived at its destination, the market then offers near 0% returns and a picking of the creditor's pocket via inflation and negative real interest rates."

Gross says Pimco will still be able to deliver returns to its investors by investing in emerging market debt with higher yields, non-dollar denominated debt, global corporate bonds or U.S. agency mortgages yielding 200 basis points over 1% treasuries.

Still, investors -- both in stocks and bonds -- may have to adjust to a period of low returns. Both Gross and Pimco's Mohammad El-Elrian have been big proponents of the "new normal" concept -- a period of below-average economic growth and low returns across asset classes.

-- Written by Shanthi Venkataraman in New York

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