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Bond market shrugs off PIMCO ditching U.S. government debt Add to ...

The world's biggest bond fund manager has placed his bets against one of the world's biggest debtors: the U.S. government.

Bill Gross, managing director of Pacific Investment Management Co. LLC, sold about $55-billion (U.S.) worth of debt last month from the PIMCO Total Return Fund, a global behemoth with $237-billion of assets. The sale reduces the fund's exposure to U.S. government debt to 0 per cent from 12 per cent in just one month.

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"He has been relatively downbeat on government Treasuries for a while," said Doug Porter, deputy chief economist at BMO Nesbitt Burns. "But this is quite the statement, I must say."

Debt markets initially reacted to news of the dramatic move with shrugs, and the price on the U.S. 10-year Treasury bond actually rose in Wednesday trading. However, it is hard to imagine the calm lasting very long.

Given Mr. Gross's vast clout in the bond market, where he is as revered as Warren Buffett is in the stock market, other investors may follow his lead, weakening bond prices and undermining the U.S. dollar and stock prices.

"The argument against U.S. Treasuries is fairly clear," said Eric Lascelles, chief economist of RBC Global Asset Management, who points to the threat of rising inflation because of surging commodity prices.

"On top of that, everyone is a little spooked by the recent European Central Bank statement that hints at imminent rate hikes, and uncertain … whether all central banks might prove more hawkish than previously expected." A concerted move by central banks to raise rates could slow the nascent global recovery, hammer bond prices and dent corporate profits.

One theory suggests that Mr. Gross sold the government debt because of his belief that the Federal Reserve's quantitative easing (QE) program, under which it creates money to buy assets, has been artificially propping up bond prices. In recent comments, Mr. Gross derided this experimental monetary policy as a Ponzi scheme.

When the second round of the QE program ends - and Mr. Gross believes it will wind down in June - then bond prices could plunge.

Some observers expect that the Federal Reserve will introduce yet another round of quantitative easing once the current program ends, to keep borrowing costs low and help stimulate the economy, which continues to suffer from stubbornly high unemployment levels. However, Mr. Gross's move suggests that he sees no such "QE3" in the works, which implies that the U.S. economy and stock prices may be in for a rough patch.

"If Bill Gross, the most connected person to the upcoming actions by the Fed, believes there is no more quantitative easing, it is really time to get the hell out of dodge in all security classes - bonds, and most certainly, equities," said the blogger Zero Hedge, who was the first to report the PIMCO sale.

Mr. Gross's high-profile exit from U.S. government debt raises the question of where he is investing the proceeds of his sale. The answer is that, by and large, he isn't.

The fund's cash levels have surged to an extraordinary 23 per cent of assets, from just 5 per cent in January. According to Wall Street Journal, the fund has raised its exposure to emerging market debt to 10 per cent, and has plans to invest in preferred shares later this year.

Remarkably, players in the U.S. Treasury market took the PIMCO move in stride. The U.S. government auctioned $21-billion worth of 10-year bonds on Wednesday, and the yield on the bond fell to 3.47 per cent from 3.55 per cent on Tuesday, meaning that bond prices actually rose.

One bond trader in New York said that the PIMCO sale might have been overshadowed by political strife in North Africa and the Middle East. Continuing violence in Libya and a "Day of Rage" planned for Friday in Saudi Arabia could be encouraging investors to view U.S. government bonds as a haven.

"If more stuff blows up in the Middle East, then Treasuries are a no-brainer," the trader said.

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