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Betting Against U.S. Government Debt

Tuesday May 10th, 2011   •   Posted by Craig Eyermann at 12:40pm PDT   •  

Bill Gross, the manager of the world’s largest bond fund at PIMCO, increased the size of his bet against U.S. government issued debt on Monday, May 9, 2011:

(Reuters) – PIMCO’s Bill Gross, the manager of the world’s largest bond fund, raised his bet against U.S. government-related debt in April to 4 percent from 3 percent, according to the company’s website on Monday.

The increase, albeit small, follows Gross’ move to ratchet up his bearishness in March by taking his initial short position in U.S. government-related debt, which includes Treasuries, TIPS, agencies, interest rate swaps, Treasury futures and options and FDIC-guaranteed corporate securities.

The $240 billion Total Return fund also raised its cash position to 37 percent in April from 31 percent in March, added Pacific Investment Management Co, which oversees $1.2 trillion in assets.

The Total Return fund took down its mortgage exposure to 24 percent in April from 28 percent the previous month.

The fund also decreased its allocation in investment-grade credit to 17 percent in April from 18 percent in March and junk bonds to 5 percent in April from 6 percent the previous month.

For their part, emerging markets exposure increased to 11 percent of the Total Return portfolio, up from 10 percent in March, and municipal bonds unchanged at 4 percent month-over-month.

Last Friday, Gross told Reuters that the only way he would purchase Treasuries again is if the United States heads into another recession.

Since the news that Gross had turned more bearish on government debt, reflecting his growing worries over the country’s fiscal deficit and debt burden, Treasury prices have been soaring.

Gross told Reuters on Friday: “Treasury yields are currently yielding substantially less than historical averages when compared with inflation. Perhaps the only justification for a further rally would be weak economic growth or a future recession that substantially lowered inflation and inflationary expectations.”

Although the Reuters article describes the size of the increase in PIMCO’s short position against U.S. government-related debt as “small” in rising from 3% to 4% of the bond fund’s portfolio of holdings, Gross effectively increased the total size of his contrarian bet against U.S. debt by 33%.

As for the nature of his bet, Gross is gambling that U.S. government issued debt will be less expensive in the future than it is today. That creates an opportunity for him to profit by borrowing U.S. government debt from its owners today, selling it at the prices he believes are too high for it, then returning it back to its owners after repurchasing it at a lower price in the future. In the meantime, PIMCO will be paying the owners of the debt the interest they would otherwise receive.

That is what we would describe as a very high risk investment strategy. It will be interesting to see how well it plays out for Gross.

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May 2011