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Time Is Running Out for Treasury Market Rally: Pimco’s Gross

Ansuya Harjani
May 15, 2012

The time where investors are no longer willing to accept negative yields on U.S. Treasurys is near, warned Bill Gross, manager of Pimco, the world’s largest bond fund.

“With the U.S. suffering a credit downgrade to AA+ and offering negative 200 basis point policy rates for the privilege of investing in Treasury bills, the willingness of creditors — as opposed to debtors — to support the existing system may soon fade,” Gross wrote in aFinancial Times editorial published on Tuesday.

“With dollar reserves widely dispersed in China, Japan, Brazil, and other surplus nations, it is fair to assume that there will come a point where 2 percent negative real interest rates fail to compensate for the advantages heretofore gained in buying sovereign bonds," he added.

Gross recently cut his exposure to Treasurys, reflecting his negative outlook for U.S. government debt. His $252 billion Total Return Fund held 32 percent in U.S. Treasurys and Treasury-related securities as of the end of March 31, down from 37 percent as the end of February, according to Pimco’s website.

In his investment outlook for May, Gross warned that inflation in the U.S., which currently stands at 2.7 percent, is set to climb and further erode returns on government debt.

“Higher rates of inflation should be the result of (quantitative easing) policies and zero bound yields that will likely continue for years to come,” he said in the note issued earlier this month. “Investors (are) being skunked and having their pockets picked simply by receiving yields less than inflation.”

Gross is not alone in his warnings regarding U.S. Treasurys. Famed investors including Wilbur Ross, Peter Schiff, and Jim Rogers have also voiced their concerns around investing in U.S. government bonds in the recent months.

In March, Wilbur Ross, chairman and founder of WL Ross & Co., told CNBC that long-term government debt posed a great threat to portfolios, cautioning that higher inflation could hammer the value of fixed-income government securities.

Peter Schiff, CEO of Euro Pacific Capital, said earlier this month that the U.S. bond market and dollar were headed for a collapse due to the inability of theFederal Reserve to service the nation’s debt with “artificially low” interest rates.

Despite those dire predictions, U.S. bond prices, which move in the opposite direction to yields, have rallied in recent months on renewed concerns over the euro zone debt crisis, a weaker economic recovery in the U.S., and worries about China’s growth outlook.

Gross, who was similarly negative on Treasurys last year, found himself on the wrong side of the trade. In 2011, he cut his exposure to U.S. government bonds, betting that prices would fall after the Fed’s second round of quantitative easing came to an end. Slower-than-expected growth in the U.S. over 2011, however, led investors to rush into the safety of government debt, forcing Gross to admit in August that it was a mistake to bet so heavily against Treasurys.

To guard investments from rising inflation, Gross recommended investors shift their focus to short-term bonds and dividend-paying stocks.

“Focus on bonds with maturities in the five-year range and stocks paying dividends that offer 3 percent to 4 percent yields,” he said in his note in May. “In addition, real assets or commodities should occupy an increasing percentage of portfolios,”