Treasury ETFs Look Vulnerable as PIMCO’s Gross Cuts Holdings

Like the boy who cried wolf, market pundits have been warning investors for years to brace for rising interest rates. So far it hasn’t happened although yields on the 10-year Treasury note have ticked a bit higher after dipping below 1.5% in July.

Now, PIMCO Total Return ETF (BOND) skipper and bond guru Bill Gross is warning investors about the risks of U.S. Treasuries if and when yields rise and inflation picks up.

Gross reduced PIMCO Total Return Fund’s position in Treasuries to 21% in August from 33% in July, according to the latest disclosure.

In a tweet from late August, Gross said even with the Fed’s latest third round of quantitative easing, or QE3, Treasury yields have “practical limits.” He said a 1.5% yield on the 10-year note is “a good common sense bottom.”

‘We are in the age of inflation’

Gross has been selling Treasuries and moving into mortgages, so PIMCO Total Return Fund and ETF both appear positioned to benefit from the Fed’s decision to expand its bond-buying program by purchasing more agency mortgage-backed securities at a pace of $40 billion a month. [PIMCO ETF ‘Well Positioned’ for Fed’s Mortgage Buying]

He has expressed concern that long-term Treasuries could get hit by inflation as the Fed continues to buy bonds. Earlier this month, Gross tweeted he believes inflation will average 2.5% or more in future years. “We are in the age of inflation,” he said.

Inflation hurts bonds because the purchasing power of the fixed income they provide is eroded.

“Bill Gross is essentially calling current levels for Treasury yields a market bottom,” Marc Prosser writers at Forbes. “Some commentators have called him ‘gutsy’ for making this call, because he was wrong the last time he made a similar bearish Treasury call. As a result his fund underperformed in 2011.”

Bond bubble?

Still, there are persistent worries that the Fed’s bond buying and the flight to safety in Treasuries in recent years have created a bubble in U.S. government debt. If yields do rise, bond investors could get hurt. Bond prices and yields move in opposite directions.

While bonds have been relatively stable investments for the past three decades, “bond prices have risen so much as interest rates have gone down that there is some concern the bubble could burst,” writes Tim Grant for the Pittsburgh Post-Gazette.

“Things may change with bonds and we don’t know when,” said Mike Maglio, investment director at PNC Wealth Management, in the article. “I think rates are headed in the other direction, but we don’t know when. Many have thought for years rates had to turn around, but they haven’t.”

Treasury ETF

The iShares Barclays 20+ Year Treasury Bond (TLT) is up 5% year to date and is lagging the S&P 500. The Treasury ETF is flat the past three months.

Chris Kimble at Kimble Charting Solutions says investors are trying to figure out whether the Fed’s QE3 will lead to increased inflation or deflation.

“Government bond yields increased and prices fell, going into the QE3 announcement and the opposite has happened since. Did this price action fool a few investors?” Kimble writes at his blog.

From a technical perspective, yields are on a rising support line while bond prices find themselves at falling resistance. The bond market is seen as “smarter” than the stock market so the next move in yields could be telling, he said.

Kimble also points out a bearish “head and shoulders” pattern playing out in TLT, the Treasury ETF. The fund is testing its 50-day simple moving average after finding support at the 200-day average earlier this month.

PIMCO’s Gross recently urged investors to get out of index-based total-market bond ETFs that have high allocations to Treasuries, and into PIMCO Total Return ETF, which he actively manages.

“Their universe is basically a 40% Treasuries universe yielding 90 basis points. You can’t produce a return out of that type of yield. I say, ‘Are these people crazy?’” Gross said at an IndexUniverse conference. [Gross Touts PIMCO ETF's Active Appraoch]

iShares Barclays 20+ Year Treasury Bond

Full disclosure: Tom Lydon’s clients own TLT.

The opinions and forecasts expressed herein are solely those of John Spence, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.