Nov. 13 (Bloomberg) -- Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., said value is diminishing in credit markets and that relative yields may rise.

Mortgage and high-yield corporate debt is “overvalued,” making Treasuries and investment-grade company debt attractive, Gross, co-founder and chief investment officer of Newport Beach, California-based Pimco, said in a Bloomberg Radio interview. Emerging-market debt is appealing to “some extent,” he said.

“That’s a limited menu, but it’s what we are presented with at the moment,” Gross said.

The sustainability of the U.S. economic recovery by the private sector after government stimulus programs end remains in question, Gross said. Below-average growth may prompt yield spreads to increase on high-yield debt and the Federal Reserve’s plan to complete its mortgage purchase program will hurt returns on those securities, he said.

High-yield, high-risk bonds have returned a record 52 percent this year, including reinvested interest, compared with 19 percent for investment-grade debt and a loss of 2.5 percent for Treasuries, according to Merrill Lynch & Co. index data. Speculative-trade bonds are rated less than BBB- by Standard & Poor’s and below Baa3 by Moody’s Investors Service.

Yield Gaps Shrink

Junk-rated debt on average yields 7.54 percentage points more than Treasuries and 5.38 percentage points more than investment-grade spreads. The gaps between the ratings groups are about the smallest since the week after Lehman Brothers Holdings Inc. filed for bankruptcy in September 2008, Merrill indexes show.

The $192.6 billion Total Return Fund managed by Gross returned 17 percent in the past year, beating 57 percent of its peers, according to data compiled by Bloomberg. The one-month return is 0.94 percent, outpacing 59 percent of its competitors. Pimco is a unit of Munich-based insurer Allianz SE.

Pimco bought government debt in September and cut mortgage bond holdings to the lowest level since 2005 after Gross warned this year that the U.S. recession will lead to a period of less- than-average growth.

Fed Chairman Ben Bernanke is scheduled to speak on the economic outlook at a lunch sponsored by the Economic Club of New York on Nov. 16. The central bank last week reiterated its pledge to keep interest rates near zero for “an extended period.”

‘Always Want to Hear’

“What we always want to hear is ‘an extended period of time’ because that zero-percent interest rate promotes asset appreciation on the longer end of the curve and in risk assets,” Gross said. “To the extent the real economy requires low interest rates, we want to see that continue.”

The Fed cut its target for overnight lending between banks to a range of zero to 0.25 percent in December.

Central bank officials will change policy “when they begin to see steady and consistent nominal GDP of 4 to 5 percent,” Gross said.

The U.S. economy grew in the third quarter for the first time in more than a year as gross domestic product increased at a 3.5 percent annual rate from July through September after shrinking the previous four quarters, a Commerce Department report showed on Oct. 29.

Pimco has called for a “new normal” in the global economy that will include heightened government regulation, lower consumption, slower growth and a shrinking global role for the U.S. economy.

Fed officials said in a statement on Nov. 4 that the central bank will purchase a total of $1.25 trillion of agency mortgage-backed securities through the first quarter of 2010.

To contact the reporters on this story: Thomas R. Keene in New York tkeene@bloomberg.net; Susanne Walker in New York at swalker33@bloomberg.net

Last Updated: November 13, 2009 11:42 EST