Betting Against QE3: Could China Follow Bill Gross?

By David Berman

For anyone who is still unconvinced about the significance of PIMCO’s U.S. government bond sale last month, here’s a scary thought from Scotia Capital’s chief currency strategist: What if China followed his lead?

On Wednesday, we reported that Pacific Investment Management Co. – headed by the Bond King himself, Bill Gross – had shed all of its U.S. government debt holdings last month from its $238-billion (U.S.) Total Return Fund, the world’s largest bond fund. (Here is my previous post on the subject.)

This was a big, bold move that suggested Mr. Gross was acting on his belief that the Federal Reserve would end its quantitative easing program (or QE2) in June, and another bond-buying plan was not in the works. Without QE3, bond prices would likely fall because the Fed accounts for about 70 per cent of bond-buying activity right now.

Still, Mr. Gross’s exit from U.S. government bonds is perhaps more important as a signal that other investors might be thinking along the same lines.

“For markets, the real concern is less that Bill Gross has eliminated his exposure but more the risk of contagion,” said Scotia’s Camilla Sutton, in a note.

“There are several large funds who have already publicly noted that they have shortened durations, but the real fear is that major buyers of U.S. debt (China) also shed exposure. The selling off of U.S. bond exposure pressures yields higher, but is undeniably a U.S.-dollar negative. Highlighting well, that rising U.S. yields do not always support the USD.”

So far, the markets don't seem that concerned though -- or, at least, other concerns are overshadowing Mr. Gross's move. The yield on the 10-year U.S. government bond fell slightly on Thursday, to 3.45 per cent, which means that bond prices rose. The U.S. dollar index also rose slightly, by 0.7 per cent, as investors scurry for safe havens amid the stock market downturn.

Here's a thought from Eric Lascelles, chief economist of RBC Global Asset Management, in a brief email chat on Wednesday, when asked about the relative lack of concern by markets:

PIMCO already had a low concentration in Treasuries so the shift is not drastic, and the market's interpretation may be that the sale has already occurred and yet the market was essentially unfazed by it. They can only go up from here in their allocation.

Disclosure: None