May 22 (Bloomberg) -- Pacific Investment Management Co.'s Bill Gross said the U.S. underestimates inflation by at least 1 percent, making some emerging markets more attractive investment candidates.

Changes in the way the Bureau of Labor Statistics measures prices over the past 25 years have led to the understating of inflation, Gross, co-chief investment officer of Newport Beach, California-based Pimco, said in a commentary on the company's Web site today. The Federal Reserve's focus on ``core'' instead of ``headline'' inflation has also helped understate the increase in prices, he said.

Pimco favors commodity-based assets and foreign equities that are denominated in currencies that demonstrate ``authentic'' real growth and inflation rates. Investors should shun U.S. Treasuries and Treasury Inflation Protected Securities, or TIPS, because of their negative ``unreal'' yields as a result of ``artificially low inflation,'' he said.

``Investors might suddenly awake to the notion that U.S. inflation should be and in fact is closer to worldwide levels than previously thought,'' Gross said. ``Foreign holders of trillions of dollars of U.S. assets are increasingly becoming price makers, not price takers, and in this case the price may not be right.''

Emerging-market countries with economies similar to those of Brazil, Russia, India and China are ``obvious'' candidates for investment as inflation quickens, Gross said.

Treasuries Decline

Treasuries fell as oil prices at a record high prompted traders to increase bets the Federal Reserve will have to raise interest rates to curb inflation. Two-year maturities led the losses as crude climbed above $135 a barrel in New York, a day after the minutes of the Fed's last policy meeting showed officials raised their consumer-price growth estimates.

The yield on the two-year note rose 14 basis points, or 0.14 percentage point, to 2.53 percent at 4:55 p.m. in New York, according to BGCantor Market Data. The price of the 2 1/8 percent security due in April 2010 fell about 1/4, or $2.50 per $1,000 face amount, to 99 7/32.

Demand for 10-year inflation-protected securities increased to the highest since March 13. The difference between yields on 10-year Treasury Inflation protected Securities and regular notes has widened to as much as 2.58 percentage points, from 2.28 percentage points on April 30.

Academic Debate

The accuracy of the consumer-price index has long been a focus of economists as well as Gross. He advised paring holdings of 10-year Treasury notes in his monthly investment outlook in September 2004 because government figures underestimate the pace of inflation.

Some economists say the measure may overstate inflation because it fails to capture changes in buying patterns on a timely basis. Others contend it understates price increases by failing to capture changes in the cost of assets, like houses.

Former Fed Chairman Paul Volcker, who engineered a surge in interest rates when battling a jump in consumer prices 18 years ago, said last week while testifying before the congressional Joint Economic Committee in Washington that there's ``a lot more inflation'' than reflected in government figures.

Global Inflation

Global headline inflation stands at 7 percent, Gross said. Prices rose 3.9 percent in the 12 months ended in April, down from a 4 percent year-over-year gain in March, the Labor Department said on May 14. The annual core rate fell to 2.3 percent in April 2007 from 2.4 percent in March.

Policy makers have raised their consumer-price estimates, according to minutes of the Federal Open Market Committee's April 29-30 meeting released yesterday in Washington. U.S. consumer prices, minus food and energy costs, are projected to rise by 2.2 percent to 2.4 percent, up from a range of 2 percent to 2.2 percent in the last forecast.

Gross's $128 billion Total Return Fund has surged 12 percent in the past year, beating 95 percent of its rivals, according to data compiled by Bloomberg. Pimco is a unit of Munich-based insurer Allianz SE.

To contact the reporter on this story: Lester Pimentel in New York at lpimentel1@bloomberg.net

Last Updated: May 22, 2008 17:00 EDT