Gross: inflationary dragons will breathe fire... so stay short duration

Pimco's Bill Gross is keeping his eye on the inflation risk and told Investors to buy only short duration bonds on the back of the Federal Reserve's easing measures.

In his latest note to clients, the manager of the world's biggest mutual fund - the $285 billion PIMCO Total Return - referred to the monetary policies of central banks as bubble-like and advised to bank only on short duration because inflation remains a risk in the years not safeguarded by Fed's most recent promises.

He argued while it may appear we are getting 'money for nothing and debt for free', Gross warned these measures will soon bite back.

'Investors should be alert to the long-term inflationary thrust of such cheque writing. While they are not likely to breathe fire in 2013, the inflationary dragons lurk in the “out” years towards which long-term bond yields are measured,' he said.

'You should avoid them and confine your maturities and bond durations to short/intermediate targets supported by Fed policies.'

At its December meeting, the Fed vowed to keep interest rates at a near-zero level so long as the unemployment rate is above 6.5% and inflation remained below 2.5% for the next year or two.

Just a month before that meeting, Gross upped exposure to treasuries from a 20% position to a 24% exposure in the fund despite a track record of criticising Fed policies as a danger to the stability of the monetary system.

QE to threaten economic growth

At a time when equities are seen as increasingly attractive for investors disappointed by low risk-return in fixed income, Gross reiterated the view that monetary policy would not impact the wider economy and as such would also not support growth assets in the long term.

'Zero-bound interest rates, QE maneuvering, and “essentially costless” check writing destroy financial business models and stunt investment decisions which offer increasingly lower ROIs and ROEs,' the manager said.

'Purchases of “paper” shares as opposed to investments in tangible productive investment assets become the likely preferred corporate choice. Those purchases may be initially supportive of stock prices but ultimately constraining of true wealth creation and real economic growth.'