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Pimco's Gross: Inflation Hurts Treasuries Appeal

U.S. government bonds hold little appeal with inflation making a strong comeback, the manager of the world's largest bond fund said on Tuesday.

Bill Gross, chief investment officer for Pacific Investment Management Co, said that value is returning to other parts of the U.S. bond market, particularly in highly rated mortgage agency securities and government-guaranteed small business loans.

Gross's comments were included in his March Investment Outlook report.

Bill Gross
Bill Gross

Turning to the credit crisis, he sees more problems stemming from the ongoing credit market turmoil, adding that securities where leverage was used to purchase commercial loans, and auto and credit card receivables will run into trouble as the economy slows.

At the same time, the Federal Reserve faces considerable problems in the already battered mortgage market, with credit growth there expected to increase at "tiny" single-digit levels
due to a buyer's strike of "significant proportions," Gross added.

The U.S. central bank has slashed its benchmark rate by 2.25 percentage points since September to the current 3 percent in an aggressive effort to spare the economy from the worst effects of a deep housing slump and credit squeeze.

After Gross' comments, long maturity Treasuries pared earlier price gains on the remarks, said Kim Rupert, managing director, global fixed income analysis with Action Economics in San Francisco.

Some time after the release of Gross' letter, U.S Treasury prices fell on Tuesday after government data for last month showed the biggest annual rise in wholesale U.S. prices since
October 1981.

Long-dated U.S. government securities such as the benchmark 10-year note <US10YT=RR> and the 30-year bond <US30YT=RR> are particularly vulnerable to rising inflation pressures, which erode bond values over time.

"If, as a bond investor, I expected 3 percent inflation (2 percent in 2008, higher in the out years), a 3 percent 5-year Treasury would not seem very appealing. Nor, I should add,
would a 3.80 percent 10-year or a 4.65 percent 30-year bond," Gross wrote.

On Tuesday morning in New York, the 10-year note was yielding 3.90 percent. The 30-year bond yielded 4.66 percent.

Unrelenting credit eruptions show no signs of easing in some fixed income sectors outside the Treasury bond market.

This year, Bristol-Myers Squibb <BMY.N>, the drug maker, took a $275 million write-off on money it had invested in auction-rate securities that it was unable to sell because of
failed auctions.

"Holders of Auction Rate Preferred Stock -- mostly wealthy investors, but also the likes of Bristol-Myers and other visible corporations -- thought they were holding AAA assets with money market liquidity," Gross said. "In this case, most of the assets probably are AAA but the liquidity has suddenly evaporated, transforming them from a 30-day to a potentially a 30-year asset."

He called the vehicle another "old maid in masquerade," referring to the card game which has a goal of avoiding holding a particular card or cards.

So far, municipalities selling many auction-rate securities have seen the rates on this debt skyrocket after investors have shunned recent auctions and Wall Street dealers did not provide liquidity.

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