The world’s biggest and most successful bond fund has ditched all its US government-related debt.
Bill Gross, manager of the $237bn Pimco Total Return fund, had warned recently that the fund was getting out of US Treasuries. When the latest batch of quantitative easing (QE2) ends in June, he reckons yields could rise substantially (ie bond prices will fall). So it’s not a huge surprise.
But it’s still quite a headline-grabber. I realise that many investors are more comfortable relating to the world of equities. For sake of comparison, this is a bit like reading that Neil Woodford is selling out of all UK stocks because he thinks prices will fall.
You might not agree with him. But how comfortable would you feel staying in the market, knowing that such a smart investor was getting out?
Of course, that could be part of Gross’s game plan…
Who will buy Treasuries when the Fed doesn’t?
In his March investment letter, Bill Gross questioned whether quantitative easing (QE) has healed the US economy, or just covered up the damage with a sticking plaster. My colleague David Stevenson looks at this question in the next issue of MoneyWeek, out tomorrow. If you’re not already a subscriber, subscribe to MoneyWeek magazine.
Gross acknowledges that QE has certainly helped to boost asset prices, just as the Federal Reserve wanted. But what happens when QE ends? Here’s the problem: “…the withdrawal of nearly $1.5 trillion in annualised cheque writing may have dramatic consequences in the reverse direction”.
Gross is just making the obvious point that if QE is the only thing that’s been keeping interest rates low and stock prices high, then we can expect some serious upheaval when it ends. If, when QEII ends on 30 June, the private sector is unable to stand on its own two feet, “issuing debt at low yields…[and] creating the jobs necessary to reduce unemployment” then “the QEs will have been a colossal flop”.
It’s the same thing we were discussing yesterday in Money Morning – what happens when the free money runs out? As far as bonds go specifically, since QEII began, calculates Pimco, the Federal Reserve has bought 70% of annualised issuance of US Treasuries. In other words: “The Treasury issues bonds, and the Fed buys them”. It’s a great scheme (“like Ponzi and Madoff”, as Gross puts it) until it stops working. When it does, the big question is: “Who will buy Treasuries when the Fed doesn’t?”
Bill Gross is no ordinary investor
Gross isn’t predicting a ‘buyers’ strike’ on the US, where no one buys Treasuries at any price. In fact, he says Pimco may well buy back in the future. But he does reckon that yields may have to rise significantly higher (and so prices fall).
We’ve written about the end of the great bond bull market a few times in the past here: Is this the end of the great bond bull market? And the good times certainly seem to be past for government debt. The yield on the ten-year Treasury bottomed at the end of 2008, at 2.05%. It’s now around about 3.5%.
But does this mean we’re going to see a full-blown blowout in the near future? It’s hard to say. The trouble is, you can’t think of people like Bill Gross (or Warren Buffett is another good example) as ‘ordinary’ investors. When these guys open their mouths, they move markets. And they’re aware of that fact. So you can’t assume that Gross doesn’t have other motives.
For a start, the assumption here is that the Fed isn’t going to do another batch of money printing. But that seems quite a big assumption to me. Ben Bernanke is a one-trick pony, even more so than Alan Greenspan was. Ben has never met a problem that he thinks can’t be solved simply by printing more money. So if the economy – or rather, the stock market – shows much sign of getting the withdrawal shakes after June, he’ll be the first to call for QEIII.
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And if anyone might benefit from the launch of QEIII, it would surely be the world’s biggest bond fund. Buy Treasuries when they’re issued, then punt them on to the Fed. It’s a nice, low-risk earner. Better yet if you can help push Treasury prices lower before the big event by publically decrying them, then buy them back cheap in anticipation of Blackhawk Ben hitting the panic button and printing more money.
The best days are past for government bonds
But what does it all mean for the ordinary investor? Well, the likes of you and I can’t play mind games with the Fed or the Bank of England. The good news is you don’t have to. Government bonds’ best days are behind them. Yes, there will be ups and downs, and if you’re a trader, you might be able to play them (our spread betting expert John Burford sometimes plays the US Treasuries market – sign up for his free email, MoneyWeek Trader).
But in the longer run, rates have a lot further to rise. Even if QEIII launches, that will only fuel further inflationary pressures. And what happens when QEIII ends? At some point the money printing has to stop, and the longer it goes on, the nastier the cold turkey phase will be.
So on the one hand, to protect yourself from the growing threat of inflation getting out of control, there’s gold. (As our sharp-eyed readers have pointed out on Merryn’s blog: When central bankers go mad, the US state of Utah is legislating to make gold and silver coins legal tender in the state – it’s an interesting development and one we’ll keep an eye on).
And if you want to go short government bonds, but without having to worry about your timing (which is the drawback of the various exchange-traded funds that allow you to do it), then you should read this piece by True Value newsletter writer Simon Caufield, written back in October last year: How to short government bonds. For more information about True Value call our customer services team on 02076333780.
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