Bond King Bill Gross Exits US Debt: Good News?

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Bill Gross says sell (Photo: Jason Reed/Reuters)

US debt may no longer be a good investment, at least for now. And that might be the good news.

Famed investor Bill Gross, who runs the PIMCO Total Return Fund, recently sold all of the US Treasury bonds is his fund’s portfolio. It’s a huge move for the manager of the world’s largest bond fund. As recently as June 2010, Gross’ fund held nearly $150 billion in US bonds. That amount has now been slashed to zero. But while the action will certainly be fodder for the crowd that thinks America is bankrupt, Gross’ moves may actually be another sign that the US economy is improving. Here’s why:

First of all, Gross didn’t sell all of his US Treasury bonds because he is worried that the US won’t be able to pay its debts. In a CNBC appearance on Thursday afternoon, Gross said credit wasn’t an issue for him. And in fact, Gross hasn’t sold all of his US debt holdings. He still owns Treasuries that mature in less than a year, which are technically called notes or bills, not bonds.

Gross sold because he thinks the price of US Treasury bonds are as high as they can go for now, and will fall. OK. That sounds bad. But you have to know a thing or two about the bond market. Bond prices and bond yields move in opposite directions. When yields rises, prices drop. That’s means Gross thinks that bond yields are set to rise (prices dropping), and that’s a good thing for everyone (other than traders of US Treasury bonds). Yields tend to rise when the economy is improving. This is what Gross had to say on CNBC:

Overvaluation [of Treasury bonds] has been dependent on the purchasing power of the Fed. When that disappears I question who will be buying [US debt] and at what price.

This is good news as well. Back when QE2 – the Fed’s bond buying program, which is scheduled to end in June – was announced many thought the economy would be so weak that we would need a QE3 as well. Gross clearly thinks the Fed is going to stop purchasing bonds in June. That would be another sign that the Fed thinks the economy is improving.

Of course, interest rates also rise, and bond prices fall, when we have a jump in inflation. And that’s likely to happen as well. But inflation can also be a sign of a better economy. And, as I have written before, the Fed is actually looking to goose inflation. The question is if they will go too far. Hyper-inflation would be a major problem. But if Gross was worried about that he would probably buy TIPs or Inflation Protected Treasuries. Instead he said he was buying corporate bonds, and emerging market bonds. The later group should protect his portfolio somewhat against inflation, but it’s not what you would buy if inflation was your main fear.

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