Pimco Says Short-Term Debt to Benefit as Summers Withdraws

Pacific Investment Management Co., which runs the world’s biggest bond fund, says short-term Treasuries will be among the biggest beneficiaries after Lawrence Summers quit the race to head the Federal Reserve.

The former Treasury secretary withdrew from consideration yesterday, ending speculation he would undo the bank’s policies aimed at holding down borrowing costs. President Barack Obama has also mentioned Fed Vice Chairman Janet Yellen as a candidate, and she’s now the front-runner for the job when Ben S. Bernanke’s term expires in January, according to Mohamed El-Erian, Pimco’s chief executive and co-chief investment officer.

“Markets will likely interpret this as significantly increasing the probability of broad policy continuity at the Fed,” El-Erian wrote in a commentary on the Business Insider website. “This would be seen as being particularly supportive for the front end of the Treasury curve,” referring to the spectrum of maturities.

Bill Gross, Pimco’s other co-chief investment officer who runs the $251.1 billion Total Return Fund, wrote on Twitter that the difference between five- and 30-year yields should widen following Summers’ withdrawal. The gap may increase by 10 basis points, or 0.10 percentage point, according to Gross. Pimco, based in Newport Beach, California, is a unit Munich-based insurer Allianz SE.

Front End

Shorter-term notes tend to follow what the Fed does with its benchmark rate, while longer-maturity bonds are more influenced by inflation prospects and the central bank’s debt purchases. Summers would have kept monetary policy tighter than Yellen, according to a Bloomberg Global Poll.

Benchmark 10-year yields fell eight basis points, or 0.08 percentage point, to 2.80 percent at 7:44 a.m. London time, according to Bloomberg Bond Trader data. The 2.5 percent note due in August 2023 rose 22/32, or $6.88 per $1,000 face amount, to 97 3/8.

Five-year yields slid 13 basis points to 1.57 percent. The difference between five- and 30-year yields widened 10 basis points to 2.24 percentage points.

The Fed cut its target for overnight bank lending to a range of zero to 0.25 percent as the financial crisis mounted in 2008, and it has vowed to keep it there until the economy and employment show sustained signs of recovery.

Taper Prospects

Policy makers are also buying $85 billion a month of Treasuries and mortgage bonds to put downward pressure on long-term borrowing costs. They will probably decide to slow purchases to $75 billion at a two-day meeting starting tomorrow, according to a Bloomberg News survey of economists on Sept. 6.

Concern over the tapering sent Treasuries down 3.8 percent this year, exceeding the biggest annual declines recorded in Bank of America Merrill Lynch data that go back to 1978.

JPMorgan Chase & Co. financial models show the end of all Fed bond buying would lift 10-year note yields by 25 basis points, which the firm says is already priced into the market.

If the Fed’s rate guidance was ended, meaning the timing of the first increase to the benchmark rate was moved forward to today, it would lift yields by 45 basis points, the model indicates.

Futures traders were pricing in a 63 percent probability last week that the Fed will increase its rate by January 2015. On May 1, the odds were 17.8 percent.

Ali Jalai, a Singapore-based trader at Scotiabank, said he’s selling 30-year Treasury futures and buying five-year contracts today.

“The market thought that Summers would raise rates earlier rather than later,” said Jalai, who trades bonds for the unit of Canada’s Bank of Nova Scotia, one of the 21 primary dealers that deal directly with the Fed. “They think that Yellen won’t raise rates for a long time.”

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