The world's biggest bond trader has gone short on U.S. Treasuries and warns investors not to trust Congress to solve the debt problem. Image: Flickr/Phil Roeder CC-BY-SA

As the federal deficit grows, the world’s largest bond trader is betting politicians will fail to prevent a U.S. debt crisis. The Pimco Total Return Fund has taken a short position on U.S. government debt in the form of Treasury bonds. Analysts are saying that Pimco has gotten out of bonds because the company expects that few investors will want Treasuries when the Fed quits buying bonds as quantitative easing ends in June.

Pimco ups the ante on U.S. Treasuries

By taking short positions on U.S. government debt, Pimco is betting that deficit financing will drive interest rates higher and endanger the nation’s triple-A bond rating. To get to a short position on Treasury bonds, Pimco sold borrowed securities on a bet it can buy them back later at a lower price. Pimco head Bill Gross has been warning investors about the risks of U.S. government debt. In February Gross caused a stir by selling all of Pimco’s Treasury holdings. In March he took it further and went net short on Treasury funds, making a $7 billion bet against the securities.
The portion of Pimco’s $236 billion Total Return Fund held in U.S. Treasuries and other long-term government debt dropped from zero in February to negative 3 percent in March. The fund’s cash equivalents rose to 31 percent of the fund’s assets, a $73 billion bet that the good times are about to end in the markets.

Behind Pimco’s short position

Gross has no faith that Congress will be able to solve the deficit problem. In an April Pimco newsletter, he said the U.S. government was “out-Greeking the Greeks.” Greece’s massive government debt forced its leaders to ask for a bailout from the European Union to prevent a global chain reaction of financial failure. In fact, current unfunded government spending on entitlements adds up to five times U.S. GDP, a debt burden much heavier than what sent Greece into crisis. The current budget battle in Congress that targets discretionary spending without addressing politically radioactive entitlements such as Medicare, Medicaid and Social Security has done nothing to bolster Gross’s confidence. “We are smelling $1 trillion deficits as far as the nose can sniff,” he said.

Will market play into Pimco’s hands?

By assuming a short position on U.S. Treasuries, Gross may be using his fund’s ability to move the market to ensure that the bet pays off. Investors have been following Pimco’s lead. As of April 5, speculators went net short on Treasuries for the first time in six weeks, according to the Commodity Futures Trading Commission. John Carney at CNBC warns investors to regard Gross’s machinations with caution. A move that is universally viewed as the right one by Wall Street often turns out to be “dangerously wrong.” If Treasuries sell off in the near future and Treasury prices fall, expect Gross to bring Pimco back into the bond market — that’s what he’s betting on.

Sources

Associated Press

Fortune

Christian Science Monitor

Reuters

In a move everyone was waiting for Wednesday, the Fed announced QE2 -- printing money to buy $600 billion in Treasurys -- an effort to stimulate the sluggish economy. Image: CC NC in DC/Flickr

Just about everyone knew the Federal Reserve would launch another round of quantitative easing after the midterm elections. What wasn’t known was just how much quantitative easing the Fed was going to launch. The suspense ended Wednesday when the Fed announced it would buy $600 billion in Treasury bonds between now and June 2011.

The Fed’s big bond purchase

The Federal Reserve hopes to jolt the sluggish economy into recovery by pumping billions of dollars into the financial system. In an effort regarded as bold, risky and unconventional, the Fed will start printing money to buy $600 billion in Treasurys. In theory, the second round of a fiscal stimulus called quantitative easing, or QE2, will lower interest rates on long-term loans, stimulate consumer spending and reinvigorate hiring. The total QE2 package could add up to $900 billion as the Fed buys even more Treasurys with $300 billion it plans to make from mortgage portfolio investments.

Markets react strangely to QE2

QE2 was no secret, but the Fed’s move, in its depth and breadth, was bolder than most analysts had anticipated. Even so, in the financial markets, which had been pricing in an even bigger Fed bond purchase, interest rates surprisingly rose following the QE2 announcement. The yield on 30-year Treasury bonds was up 0.17 points to 4.09 percent. Ten-year Treasury bonds rose 0.04 points to 2.6 percent. The stock market also favored the news. The Standard & Poor’s 500 index was up 0.2 percent.

Fed has no faith in Congress

A few months ago the Fed considered a return to normal monetary policy, which has been customary following a recession. That would include raising interest rates and tightening credit. However, the possibility of continued political gridlock based on the outcome of the midterm elections convinced Fed chairman Ben Bernanke to act. Because the Fed can’t count on Congress to do anything to stimulate the economy, Bernanke has said, he will use all the tools at his disposal to stimulate employment and get the economy back on track.

Sources

New York Times

Washington Post

USA Today