Committee for a Responsible Federal Budget

Pimco Eliminates Government Debt Holdings and Spain Gets Downgraded

Mar 10, 2011

PIMCO founder Bill Gross - the managing director of the world's largest bond fund - made headlines today when it was reported that he eliminated all US government-related debt from his Total Return Fund last month. The fund totals $237 billion, and Gross had already cut its holdings of government debt to 12 percent in January.

In a statement made earlier this month, Gross said that yields on U.S. Treasuries may be too low to sustain current demand for U.S. debt. This comes as the Federal Reserve is nearing the end of its second phase of quantitative easing, whereby the Fed will have invested about $600 billion in U.S. debt by June. Gross asked, "Who will buy Treasuries when the Fed doesn't? ...The question really is at what yield and what are the price repercussions if the adjustments are significant."

This move from PIMCO seems to largely reflect an improving economic recovery, as other investments become relatively more attractive than U.S. debt as risk-aversion slowly recedes. This is a positive development (for the economy, not the budget) as recent safe-haven effects have pushed interest rates on U.S. debt to incredible lows. Although a move like this will help drive interest rates up as investments move out of government holdings and into more productive private investments, higher interest rates will mean larger yearly interest payments on our existing debt--squeezing out the budgetary room for other spending priorities.

It is unclear the extent to which this move may reflect longer-term worries about the safety of investing in U.S. debt. In either case, we need to enact a comprehensive plan to ensure that U.S. government debt will always be a good investment and to keep interest rates (and payments) as low as possible.

NPR also reported on another issue concerning U.S. government bonds, specifically the concern that "nervous investors would likely ditch Treasuries en masse as the US government gets closer to the debt ceiling". (Click here to read CRFB's view on approaching the debt ceiling)

In other news, investors will most likely reduce their holdings of Spanish debt for different reasons. Moody's has downgraded Spain's sovereign debt rating from AAA to Aa2, citing concerns about the potential cost to the government of restructuring the country's central banking system. They estimate it will cost up to 40 or 50 billion euros, as compared to the Spanish government's cost estimate of only 15 billion euros.