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Behind the Rush Into T-Bonds

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TIMES STAFF WRITER

The Bigfoot of the bond market acknowledged Thursday that he may have helped cause “the spark” that set the Treasury bond market on fire.

William H. Gross, bond chief at Pacific Investment Management Co. in Newport Beach, whose $180-billion bond portfolio is the world’s largest, acknowledged that Pimco’s heavy purchases of 30-year T-bonds in recent weeks helped set off a stampede by other investors that has produced one of the sharpest drops in T-bond yields in years.

Because of its size, Pimco is often the focus of rumors when there is unusual activity in bonds. Often the rumors are unfounded, but “I think this time we are partly responsible,” Gross said in a telephone interview from Quebec City, Canada, where he is vacationing.

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He added, however, that the “panic buying” in the Treasury market this week probably peaked Thursday and that things ought to calm down from here.

In any event, Gross noted, the general public so far is little affected by the turmoil because the drop in T-bond yields has not been matched by similar changes in the rates that really matter to consumers, such as 30-year mortgage rates. And however much home buyers might welcome a collapse in mortgage rates, it doesn’t appear likely in the near future, he said.

In just 10 trading days, the yield on the 30-year Treasury bond has plummeted to 6.14% from a peak of 6.75% on Jan. 20.

What’s so terrible about lower bond yields? On the face of it, nothing. But traders say much of what propelled the frenzy of the last two days was “forced buying” by bond traders and investors who found themselves on the wrong side of a bet on the direction of Treasury yields.

And ironically, according to analysts, some victims of the violent market move were using conservative “hedging” strategies meant to protect them from bond market volatility, not play into it.

Gross, one of the most respected voices in the bond market, said he and other pros have been slow to grasp the implications of changes brought on by the nation’s budget surplus on one side and the actions of the Federal Reserve on the other.

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The slide in T-bond yields followed the Treasury’s announcement Wednesday that it would cut the size of its debt auctions more than expected and carry on with its plan to buy back long-term debt, thus shrinking the supply of bonds.

It shouldn’t have been a big surprise, since the Treasury had been telegraphing its plans for months. Yet the market was caught flat-footed. Traders who had “shorted” long-term T-bonds--a bet that the Fed’s determination to slow the economy with increases in short-term rates would push up long-term rates as well--had to rush into the market and buy T-bonds to reverse those losing bets.

By contrast, about a month ago, Gross said, Pimco decided to start buying 30-year T-bonds and selling shorter-term securities, including mortgage securities and T-notes.

This was the reasoning, as Gross explained it Thursday:

The stock market has come to believe, correctly or not, that even as the Fed tightens credit, it will always stand ready to slash rates in any crisis that would threaten to capsize the market. As long as investors feel this way, stock prices are likely to remain higher than would otherwise be the case, in turn feeding the economy. Thus, it will take more effort by the Fed--more increases in the shorter-term rates it controls--to subdue the economy.

To Gross, the outcome seemed clear: an “inverted yield curve,” wherein short-term bond yields are higher than long-term yields, because while the Fed is pushing up short rates, Uncle Sam is effectively pushing down long-term yields by cutting the supply of bonds.

The implication for a smart bond investor thus was to move as far away from the shorter-term end of the market as possible--and buy long-term T-bonds like crazy.

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Over a few weeks, Pimco bought $5 billion of 30-year T-bonds and sold $8 billion to $9 billion of intermediate-term securities, Gross said.

Though his prediction of a bond-yield inversion came true, he hadn’t counted on its happening so fast, he said. In recent days, other traders and investors caught on and started doing the same thing as Pimco.

Gross is glad he was right but is sorry he couldn’t have made an even bigger bet. Now, he believes that although T-bond yields probably won’t fall much further, the yield inversion could last for months, even into 2001.

But without a slower economy, many analysts doubt that mortgage and other long-term rates will follow Treasury yields down. And the volatility in the Treasury market--supposed to be a more stable and predictable market--could just breed more confusion all around.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Bond Yields: Now What?

Long-term Treasury bond yields plunged this week as the market suddenly woke up to Uncle Sam’s plans to buy back debt--causing some investors to rush to buy, fearing a shortage of securities. But it remains to be seen if yields on other types of bonds, and on mortgages, will fall as sharply. Weekly closing yields and latest for the 30-year Treasury bond, the Bloomberg 10-year high-rated industrial bond index and the Freddie Mac benchmark 30-year, fixed-rate mortgage:

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Shorter-Term Beats Longer-Term

. . . at least in terms of Treasury yields. The wild divergences in interest rates in recent weeks have left two- and five-year Treasuries paying more than longer-term issues. Current yields on Treasuries of various terms:

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Source: Bloomberg News

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