Pimco’s Gross Says Fed to Shift Operation Twist to Mortgages

Bill Gross
Bill Gross, co-chief investment officer of Pacific Investment Management Co. Photographer: Scott Eells/Bloomberg

Pacific Investment Management Co.’s Bill Gross said the Federal Reserve will probably shift focus to mortgage securities to keep borrowing rates low when its so-called Operation Twist program ends in June.

It will be a “twist on another twist going forward,” Gross, who runs the world’s biggest bond fund, said from Pimco’s headquarters in Newport Beach, California, during an interview on Bloomberg Television’s “InBusiness with Margaret Brennan.”

Fed Chairman Ben S. Bernanke said this week unemployment remains too high, the U.S. economic recovery isn’t assured and policy makers don’t rule out any further options to boost growth, including additional debt purchases. Investor expectations for more monetary stimulus declined after Fed policy makers raised their assessment of the economy March 13.

“The Fed is outcome oriented,” Gross said. “And what he said on Monday in terms of the employment picture basically suggested that, up until now we’ve done very well in terms of reducing unemployment but it will be a tougher row to hoe going forward.”

The central bank is pursuing a maturity-extension program announced in September to replace $400 billion of short-term debt in its portfolio with longer-term securities. The Fed purchased $2.3 trillion of debt in two rounds of quantitative easing that have become known as QE1 and QE2 as part of its efforts to support the world’s biggest economy.

Sterilized Twist

What the Fed will “try to do is twist in the mortgage market; basically buy current-coupon mortgages in agency space, 3 percent and 3.5 percent coupons,” Gross said. “And basically twist by repoing out the Treasuries they currently own in short-term space.”

A so-called sterilized version of debt purchases would involve the Fed buying longer-term debt while draining cash from the banking system through the repurchase agreement market, preventing a rise in bank reserves. This option may allow the central bank to take further action to bolster growth while containing investors and political leaders’ concern the actions might threaten future inflation.

Repos are transactions used for short-term funding, typically involving the sale of U.S. government securities in exchange for cash, with the debt held as collateral for the loan. In a reverse repo, the Fed lends securities for a set period, temporarily draining cash from the banking system. At maturity, the securities are returned to the Fed, and the cash to its counterparties.

Buying Mortgages

Pimco’s $252 billion Total Return Fund reduced holdings of Treasuries last month for the first time since February 2011, when it cut its stake in the securities to zero.

Gross lowered the proportion of U.S. government securities in the fund to 37 percent of assets from 38 percent in January, according to a report on the company’s website. He raised mortgages to 52 percent from 50 percent.

The Total Return Fund has earned 2.9 percent for investors this year, beating about 97 percent of its competitors, according to data compiled by Bloomberg. The fund has gained 0.1 percent over one month, topping 80 percent of rivals, the data show.

Pimco, a unit of the Munich-based insurer Allianz SE, managed $1.35 trillion of assets as of September.

The five-year notes that Russia plans to sell offer more value than U.S. Treasuries of the same maturity, Gross said.

Russian Debt

“At 230 basis points over the U.S. five-year, that’s an attractive situation,” Gross said. “It’s a BBB+ type of security in terms of sovereign space. Obviously it has a history of default -- 10 to 11 to 12 years back. But we think at these spreads, and with the situation currently, it’s an attractive situation compared to U.S. Treasures.”

The Russian government is issuing $2 billion of five-year bonds at 230 basis points over U.S. Treasuries, $2 billion of 10-year bonds at a spread of 240 basis points and $3 billion of 30-year bonds at 250 basis points, said a banker with knowledge of the deal who declined to be identified because the information isn’t yet public. The yield spread on a 2044 bond for similarly rated Mexico is 150 basis points and 131 basis points for Brazil’s note due in 2041.

The last time Russia issued 30-year notes was in August 2000, two years after its $40 billion domestic debt default. The sale will be the biggest among emerging markets since Qatar issued $7 billion of bonds in November 2009.

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