Bill Gross, Jeffrey Gundlach and Dan Fuss, whose firms collectively oversee about $1.5 trillion, expect the Federal Reserve to conduct a third round of bond purchases as signs of strength in the U.S. economy fade and Europe's sovereign-debt crisis returns.
The managers at Pacific Investment Management Co. and DoubleLine Capital LP favor mortgage debt as Loomis Sayles & Co. purchases corporate bonds. Speculation that the Fed (FARBAST) will buy home-loan debt with quantitative easing has led 2012 returns on government-backed mortgage bonds to exceed Treasuries by 0.96 percentage point, Barclays Plc index data show.
Fed Chairman Ben S. Bernanke, Vice Chairman Janet Yellen and New York Fed President William C. Dudley signaled further easing may be needed if growth lags behind projections, with headwinds ranging from the end of tax breaks to $1 trillion of mandatory federal budget cuts to $100-a-barrel oil eating into consumer spending. The Standard & Poor's 500 has fallen as much as 4.8 percent from an almost four-year high on April 2.
"Should the stock market keep going down, it will be a portent of weaker economic data," said Gundlach, whose $22.8 billion DoubleLine Total Return Bond Fund (DBLTX) outperformed 99 percent of peers last year. "It will happen and when it does you will start to hear about more support programs."
Gross, Fuss
While gross domestic product grew at a 3 percent pace in the last three months of 2011, it will slow to 2.3 percent this year, according to the median estimate of 90 economists surveyed by Bloomberg.
Gross, the manager of the world's biggest bond fund, boosted holdings of mortgages last month to the most in almost three years. Fuss, a member of the Fixed Income Analysts Society Hall of Fame, said this week that the Fed may stick with quantitative easing until after the presidential election or the unemployment rate falls to about 6 percent from its current 8.2 percent.
Elsewhere in credit markets, strategists at JPMorgan Chase & Co. (JPM) lowered their recommendation on U.S. investment-grade corporate bonds to neutral from overweight, saying that uncertainty about Europe's fiscal crisis will limit returns for the debt.
JPMorgan's Eric Beinstein, head of the New York-based bank's top-rated high-grade strategy team, said in a report today that the extra yield the bonds pay more than similar- maturity Treasuries is unlikely to tighten much in the next few months as the European situation weighs on investor demand.
Default Swaps Rise
"We believe renewed uncertainty in peripheral Europe will limit the ability of spreads to tighten meaningfully over the next couple of months," Beinstein wrote in the report. That will counter expected positive developments in the Chinese and U.S. economies, he wrote.
A benchmark gauge of corporate credit risk in the U.S. rose for the first time in three days, with the Markit CDX North America Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, increasing 3 basis points to a mid-price of 99.8 basis points as of 11:53 a.m. in New York, according to Markit Group Ltd.
The index rises as investor confidence deteriorates and falls as it improves. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
Bonds of Goldman Sachs Group Inc. are the most actively traded U.S. corporate securities by dealers today, with 47 trades of $1 million or more as of 11:55 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Mortgage Bonds
The mortgage-bond market is showing investors anticipate more stimulus from the Fed. Yields on Fannie Mae's current- coupon 30-year mortgage bonds ended yesterday at 88 basis points more than 10-year Treasuries, down from about 100 basis points on Dec. 31, according to data compiled by Bloomberg. The type of securities, which most affect home-loan rates because they trade closest to face value, may be targeted by the Fed.
Primary dealers agree with investors, with 15 of the 21 firms that trade with the Fed saying odds are that the central bank will need a third round of bond purchases to bolster the economy, according to a Bloomberg News survey published April 2.
In its first two rounds of stimulus in response to the credit crisis, the Fed bought $2.3 trillion of bonds from December 2008 to June to avert deflation and spur growth. It's now replacing $400 billion of shorter-term maturity Treasuries in its holdings with longer-term debt in a policy traders call Operation Twist.
Policy Makers Meet
Central bankers next meet in two weeks to debate policy for an economy that Dudley and Yellen said may be softening. Projections for GDP growth this year are slower than the 3.1 percent posted in 2005 and 2.7 percent in 2006 before the recession and financial crisis.
Fed officials called for additional stimulus only "if the economy lost momentum" or if inflation stays below their 2 percent inflation target, according to minutes of their March 13 meeting released April 3.
"Considerable uncertainty surrounds the outlook," Yellen said April 11 in a speech in New York. "I consider a highly accommodative policy stance to be appropriate in present circumstances."
'Still Too Soon'
Dudley, in a speech yesterday to business leaders in Syracuse, New York, said "it is still too soon to conclude that we are out of the woods."
Europe's fiscal imbalances are again threatening to infect the global financial system, with yields on Spanish 10-year bonds topping 6 percent this week, approaching the 7 percent level that prompted Greece, Ireland and Portugal to seek bailouts.
"The problems in Europe are getting bigger," Mohamed El- Erian, co-chief investment officer of Pimco, said April 11 on Bloomberg Radio. "Europe has a debt issue and Europe has a growth issue, and until Europe deals with both, we are going to have these reoccurring periods of nervousness in the market."
Tax reductions enacted by former President George W. Bush are scheduled to expire at the end of 2012 and $1 trillion in automatic cuts in government spending will begin in January. Crude oil prices have soared to $103.67 a barrel, from last year's low of $75.67 on Oct. 4.
It's "far too early to declare victory," Bernanke said in a March 27 interview with ABC News.
Hawkish Tone
Some Fed policy makers have struck a more hawkish tone. Atlanta Fed President Dennis Lockhart, a voting member of the Federal Open Market Committee this year, said in an April 3 interview on Bloomberg Radio that he would need to see some "pretty severe circumstances" before he would endorse more quantitative easing.
"With an improving economy, the argument for extraordinary measures frankly becomes less tenable," said Kenneth Taubes, chief investment officer in Boston for Pioneer Investment Management Inc., which oversees almost $30 billion in bonds.
Pimco's Gross raised the $252.4 billion Total Return Fund (PTTRX)'s holdings of mortgage bonds to 53 percent of assets in March, the highest since June 2009, from 52 percent in February, according to a report on the company's website on April 11. He reduced the proportion of U.S. government and Treasury debt to 32 percent last month from 37 percent in February.
Operation Twist
The Fed will probably shift focus to buying mortgage securities to keep borrowing rates low when its Operation Twist program ends in June, Gross said in a March 28 interview on Bloomberg Television.
"Without QE, the financial markets and then the economy will falter," Gross said in a Twitter post April 4. In a post yesterday, he wrote that speeches this week by Yellen and Dudley damped the probabilities of QE3.
Gundlach said softer economic numbers would push the Fed to act.
"I just don't think that we have a healthy fundamental foundation for the economy and therefore surprises are likely to be on the negative side," Gundlach said in a telephone interview from Los Angeles. His fund, which invests in mortgages, had 34 percent of its money in non-agency residential mortgage-backed securities as of March 31, according to the DoubleLine website.
Fuss's $21 billion Loomis Sayles Bond Fund favors corporate bonds, according to Matthew Eagan, one of the portfolio managers. "We like them in a scenario in which the U.S. economy muddles through," Eagan said in a telephone interview. Europe's debt crisis is another issue that may tilt the Fed toward more easing.
"Bernanke, Yellen and Dudley are all biased towards additional easing," Robert Michele, global chief investment officer for fixed income and currency at JPMorgan Asset Management, said in a telephone interview from New York.
Michele, who oversees $125 billion in fixed-income assets, predicted the central bank would come back with more easing “as we get into summer and fall” in the U.S.
John Embry & Chris Waltzek – April 11, 2012.