By Tony D’Altorio
The $237 billion Pimco Total Return Fund is the world’s biggest bond mutual fund. It is run by one of the most influential persons in the bond market – Bill Gross.
So when Mr. Gross speaks, people usually listen. And recently, he has spoken volumes – both in his words and in his actions.
In his March investment outlook for shareholders, Mr. Gross said that Pimco estimated that the Federal Reserve had been buying 70% of annualized issuance of U.S. Treasuries since its QE2 (quantitative easing/ money printing) program began. Mr. Gross last year aired his views on QE2, likening it to a Ponzi scheme.
In his latest statement, Mr. Gross said he was worried about – at the least – a temporary void in demand for U.S. Treasuries once QE2 ends in June. If he is correct about that, the yields for these bonds will rise and the prices will fall. This will hurt anyone holding Treasuries in their portfolio.
That’s why Mr. Gross has taken action to protect his shareholders. His Pimco Total Return Fund cut its holdings of U.S. government-related debt to zero for the first time since early 2008.
Now the fund holds approximately 23% in cash. The remainder is invested in U.S. mortgage bonds, corporate bonds, high yield bonds and emerging market debt.
In apparent agreement, other investors recently poured $500 million new money into ETFs set to profit if U.S. yields rise. That group includes ProShares Short 20+ Year Treasury (NYSE: TBF) and ProShares Short 7-10 Year Treasury (NYSE: PST).
Pimco Dumps Treasuries Based on Fed Direction
The Total Return Fund’s dumping of Treasuries was based on the direction of Federal Reserve policies. But another key factor in determining interest rate moves will be the pace of the U.S. recovery.
Mr. Gross is actually a rather lonely voice in the bond market. Most bond investors are very gloomy about the U.S. economy and argue that rates will stay low for a very long time.
One argument countering the case for a jump in interest rates is the concern about the impact on consumers of the sharp rise in oil and other commodity prices.
- The argument goes that higher food and oil prices will drag on the economy rather than stoke broader inflation. Under this reasoning, higher commodity prices act as a tax on U.S. consumers, slowing the economy.
- Another factor dragging on the economy is how states with large deficits are under pressure to cut spending and raise revenues.
- In addition, many U.S. homeowners are still stuck in negative equity positions after sharp falls in property prices. And the sharpest private sector deleveraging since the Great Depression continues to go on.
All of these negative factors, the gloomsters say, are working against the massive flood of monetary stimulus that the Federal Reserve has unleashed.
The Fed’s Trillion-Dollar Treasury Holdings
The Federal Reserve has indeed unleashed a tsunami of money. It has been buying about $100 billion of bonds a month through its QE2 program. Since last November, it has accumulated $419 billion of government debt. That takes the Fed’s current total Treasury holdings to $1.23 trillion.
By the time QE2 ends in June, the Fed will have bought approximately $800 billion of Treasuries, pushing its total holdings to $1.6 trillion!
So Mr. Gross’ question about who steps in to fill the gap when QE2 ends is therefore a very pertinent question… just probably not the right one to ask. Because when QE2 ends, it is highly likely there will be a QE3 and a QE ad infinitum.
Continued easy monetary policies from the Federal Reserve will actually have very little to do with the state of the U.S. economy, but a lot to do with the health of US financial institutions.
Most major U.S. financial institutions are loaded to the gills with U.S. government bonds. And they are either not hedged at all or poorly hedged against a rise in interest rates.
Therefore any cutoff of Fed purchases of U.S. Treasuries is most unlikely. The Fed does not want a replay of the 1994 devastation in the bond market. Not with so many U.S. financial institutions still on shaky ground. The monetary floodgates will stay wide open.
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