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Friday, December 10, 2010 6:45 PM


Bond Massacre Hits Treasuries, TIPs, Munis, Mortgages; PIMCO Among Biggest Losers; Is the Bond Bull Finally Over?


The treasury market has slapped Bernanke silly. Yields have soared ever since QE II was finalized in November. Mortgage rates are up a half-percent in a month and Bankrate shows they are about at the same level as a year ago. Treasuries, TIPS, and municipal bond funds have all been hit hard in the past few weeks. Matters took a turn for the worse when President Obama agreed to a tax compromise that will cost close to $900 billion.

With that backdrop, please consider Pimco Total Return Among Biggest Losers as Bond Rally Fizzles

Bill Gross’s Pimco Total Return Fund, the world’s largest mutual fund, was the second-biggest decliner among the largest U.S. bond managers in the past month as clients pulled money for the first time in two years amid a selloff in Treasuries.

The $250 billion Pimco Total Return fell 3 percent in the 30 days through Dec. 8, trailing all but one of the 10 largest bond mutual funds, which lost an average of 2 percent, according to data compiled by Bloomberg. Only the $33 billion Vanguard Inflation-Protected Securities Fund declined more, falling 3.9 percent in the period.

Benchmark 10-year Treasuries had their biggest two-day slump since September 2008 this week after tax cuts, signs of an economic recovery and asset purchases by the Federal Reserve fueled expectations inflation will accelerate. The losses may surprise investors who poured $267 billion into fixed income funds this year through October, ignoring warnings by Gross that the 30-year bond rally may have run its course.

“This is a very violent move we had this week,” said Richard Saperstein, managing director at Treasury Partners in New York, which oversees $10 billion in assets. “I think we’re going to have a very volatile bond cycle here over the next two years.”

“Check writing in the trillions is not a bondholder’s friend,” Gross wrote in monthly investment outlook on Pimco’s website on Oct. 27. “It is in fact inflationary, and, if truth be told, somewhat of a Ponzi scheme. It raises bond prices to create the illusion of high annual returns, but ultimately it reaches a dead end where those prices can no longer go up.”

Tax-exempt bonds had their worst monthly returns of 2010 in November as rising U.S. Treasury yields and record state and local fixed-rate debt sales sparked withdrawals from mutual funds investing in municipal securities. Taxable bond funds have continued to draw money, ICI data show.
Yield Curve As of 2010-12-10



click on any chart in this post for sharper image

Note the bearish flattening of the yield curve. Rates are generally rising but they are rising faster in the middle part of the curve than the long end of the curve. The Fed has pinned the extreme short end if the curve to zero.

Mortgage Rates




Chart courtesy of Bloomberg.

TIPZ - PIMCO Broad US TIPS



TIPZ is down 6.3% since the peak about a month ago, nearly all of its gains for the entire year.

SXMTX - Smith Barney Municipal Fund



SXMTX is down 4.9% since the peak about a month ago, over half of its gains for the entire year. I do not like municipal bonds here at all, for multiple reasons. There is enormous supply coming on, rates in general are going up, I expect bankruptcies to rock the sector next year, and the Build America Bond (BAB) program will likely not be extended, nor should it be. I will have more on BABs early next week.

IEF - Barclays 7-10 Year Treasury Fund



IEF is down 6.5% from the highs but it is still up 8.7% since beginning of the year. For IEF and TLT (the Barclays 20+ Year Treasury Fund) we have to watch to see if reflation continues or withers on the vine.

I do not have strong feelings on IEF one way or another. Much depends on the timeframe in which you are trading. However, if yields break substantially North from here, the 30-year bond bull may have breathed its last gasp in October when 3- and 5-year treasury yields hit record lows.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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