The selloff in Treasuries has gone too far as markets misread the Federal Reserve’s signal it may slow bond purchases by bringing forward expectations for interest-rate increases, Pacific Investment Management Co. said.
In mapping out a timeframe to end the bank’s $85 billion in monthly asset buying, the Fed is trying to ease the path for Chairman Ben S. Bernanke’s successor after his term ends in January, said Scott Mather, head of global portfolio management at Pimco, which runs the world’s largest bond fund.
Mather said his “favorite trade” is taking advantage of the steepness of the U.S. yield curve where the difference between two- and 10- year rates climbed to the highest since July 2011 yesterday.
“Markets have misinterpreted and overshot,” Mather said in a phone interview today from Auckland. “It’s most likely that the Fed is at zero for another couple of years and the markets are, in our view, overshooting in bringing forward rate hikes at a time when both inflation and growth are well below the Fed’s targets.”
Newport Beach, Calif.-based Pimco managed $1.97 trillion of assets as of June 30.
Policy makers were “broadly comfortable” with Bernanke’s plan to start reducing bond buying this year if the economy improves, minutes of the Fed’s last meeting showed Aug. 21. The Fed reiterated it plans to keep rates near zero at least as long as unemployment is above 6.5 percent and inflation is projected to be no more than 2.5 percent within one to two years.
The FOMC will probably vote next month to scale back its unprecedented stimulus program, according to 65 percent of economists surveyed by Bloomberg Aug. 9-13. The first step may be to reduce monthly purchases by $10 billion, according to the median estimate in the survey of 48 economists. They said buying will probably end by mid-2014.
“In some way it removes uncertainty about whoever the next chairman is and what their viewpoints will be, because the FOMC has basically locked down policy, at least a road map for the next nine months,” said Mather. “If you believe QE has acted in place of rate policy because they’ve been bounded at zero, you can say that removing QE means it will be longer before they do their first rate hike.”
The Fed’s preferred inflation gauge, the personal consumption expenditures index, increased 1.3 percent in the 12 months ended in June. Excluding food and energy, the index rose 1.2 percent, near the lowest since March 2011. The FOMC targets 2 percent inflation.
During the second quarter, gross domestic product rose at a 1.7 percent annualized rate, after a 1.1 percent gain in the first quarter, according to the Commerce Department. FOMC participants predicted in June that GDP will grow this year from 2.3 percent to 2.6 percent.
Treasury 10-year yields have risen 1.17 percentage points this year to 2.92 percent as of 7:40 a.m. in New York after touching a two-year high of 2.93 percent yesterday. The backup in yields spurred investors to pull out of bond funds, including Pimco Total Return Fund, the world’s biggest at $262 billion.
The fund, managed by Pimco founder Bill Gross, has lost 4.1 percent this year, putting it in the 21st percentile among similar funds, according to data compiled by Bloomberg. Over the past five years, the Total Return Fund has returned 6.9 percent, outperforming about 88 percent of competitors.
The flagship increased holdings of Treasuries and other U.S.-government-related debt in July to 39 percent, the highest level since April. Clients pulled an estimated $7.5 billion from the fund last month, research firm Morningstar Inc. said Aug. 2.