(Bloomberg News) Eight months ago Bill Gross, manager of the world's biggest bond fund, said Treasuries "may need to be exorcised" and cleaned them out of his $245 billion Total Return Fund. The company then used derivatives to bet against the debt in March.

Now the Pacific Investment Management Co. fund has 16 percent of its assets in U.S. government securities as the debt posted the highest quarterly returns in almost three years.

"We've rebalanced," Mohamed A. El-Erian, chief executive officer and co-chief investment officer at Newport Beach, California-based Pimco said in a Sept. 27 radio interview on Bloomberg Surveillance with Tom Keene in New York. "The U.S. benefits the most from a flight to quality."

With the economy growing slower than forecast, the biggest bond rally in three years has repudiated Standard & Poor's Aug. 5 downgrade of the U.S. AAA credit rating and driven yields to record lows, prompting bears to play catch up in a bid to match indexes portfolio managers use to measure performance. Economists have cut their estimates for the 10-year yield in March 2012 to 2.56 percent, from a projection of 3.75 percent in July, the biggest cut since January 2009.

A Deutsche Bank AG measure of asset allocation among the 20 largest non-indexed funds indicates that since early August they have pulled close to even with the benchmark Barclays U.S. Aggregated index weighting of 34 percent in Treasuries.

The funds Deutsche Bank tracks started "throwing in the towel" when 10-year yields fell to about 2.25 percent, Dominic Konstam, head of interest-rate strategy at the bank in New York, one of the 20 primary dealers that trade with the Federal Reserve, said in a Sept. 26 telephone interview.

Additional demand for Treasuries from fund managers may push the 10-year note yield to 1.25 percent, Konstam said.

As the likelihood grew that lawmakers in euro-member countries would approve an expansion of the European Financial Stability Facility, Treasury 10-year yields rose eight basis points, or 0.08 percentage point, last week as the price of the benchmark 2.125 percent security due August 2021 fell 24/32, or $7.50 per $1,000 face amount, to 101 27/32.

The two-year yield rose two basis points to 0.24 percent for the first consecutive weekly increase since April, even as investors bid $3.76 for each dollar of debt sold at a $35 billion action of the securities Sept. 27, the most in a year. Bids at the five- and seven-year note offerings the next two days were the most since May.

Below the Benchmark

Treasury 10-year yields declined five basis points to 1.86 percent as of 9:45 a.m. in New York. Two-year rates were little changed at 0.24 percent.