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Pimco's Gross boosts bet that Treasury bond yields will surge

As the U.S. Treasury gets set to issue another $66 billion in notes and bonds this week, Pimco bond guru Bill Gross has a message for potential buyers: Stay away.

Gross, who manages the $236-billion Pimco Total Return bond fund in Newport Beach, in February sold the last of his Treasury bond holdings from the mammoth portfolio after saying interest rates were too low to justify holding Uncle Sam’s debt.

Billgross Now he has gone a step further in the fund, taking government bond holdings to a “negative” 3% of the portfolio as of March 31, according to updated data from Pimco.

A negative holding typically indicates the fund is “short” that amount of bonds, meaning it has borrowed the securities and sold them, expecting their market prices to drop. Gross also could be using derivative securities to bet on lower Treasury prices. In the case of bonds, falling prices would mean rising interest rates.

Another sign that Gross expects longer-term rates to rise: He was keeping 31% of the fund’s assets in cash at the end of March, a big jump from 23% in February and just 5% in January. That's a lot of idle money to put to work at some point.

The rest of the portfolio was diversified among mortgage-backed bonds, corporate bonds, foreign debt and municipal bonds.

The Pimco Total Return fund was up 1.5% year to date through Friday, beating 84% of its peer funds, according to Bloomberg data.

Gross, 66, has been highly critical of the federal government’s massive budget deficits and of the Federal Reserve’s program of buying Treasury securities for its own account. In his March commentary on Pimco’s website, he estimated that Treasury bond yields were artificially depressed by as much as 1.5 percentage points because of the Fed’s bond-buying program, known as quantitative easing.

In his April commentary, Gross painted a grim picture of the federal budget outlook. He railed against “Washington’s inability to recognize the intractable: 75% of the budget is non-discretionary and entitlement based. Without attacking entitlements -- Medicare, Medicaid and Social Security -- we are smelling $1 trillion deficits as far as the nose can sniff.”

Unless entitlements are slashed, Gross said, the government will end up defaulting on its debts, though not in the standard way of halting interest or principal payments. Rather, he wrote, default would occur “surreptitiously via accelerating and unexpectedly higher inflation . . . deceptively via a declining dollar -- currently taking place right in front of our noses . . . and stealthily via policy rates and Treasury yields far below historical levels -- paying savers less on their money and hoping they won’t complain.”

Despite Gross’ latest warning to avoid Treasuries, the government bond market was stable Monday: Yields were down slightly from Friday, even though the market faces another deluge of supply this week. The Treasury will sell $32 billion in three-year notes Tuesday, $21 billion in 10-year notes Wednesday and $13 billion in 30-year bonds Thursday.

10yr411 Treasury yields tumbled in mid-March as some investors sought a haven after Japan’s massive earthquake, but they have since rebounded. Still, yields remain below their levels of early February.

The 10-year T-note yield (charted, at left) was 3.56% on Monday, up from 3.17% on March 16 but down from 3.74% on Feb. 8.

-- Tom Petruno

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Photo: Pimco's Bill Gross. Credit: Pimco funds

 
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