Pimco's El-Erian: Safety First*

Peter C. Beller

Investor likes high-grade bonds but not *Treasuries, what with $2.5T in supply ahead.

Bond investors should stick to the safest instruments available, but not Treasuries, according to bond maven Mohamed El-Erian.

The chief executive of bond fund giant Pacific Investment Management said he sees growing U.S. unemployment rolls as a sign that companies are slashing workers in anticipation that the recession will get worse. Unemployment numbers released Friday by the U.S. government showed that jobless rate was 8.1% in February. Employers laid off 650,000 people last month. (See "Pink Slips Pile Up In February.")

Investors should stick to investments that offer the protection of the U.S. government without being direct obligations of the Treasury, said El-Erian. For example, Pimco has been buying bank debt guaranteed by the Federal Deposit Insurance Corp. and mortgage bonds issued by Fannie Mae (nyse: FNM - news - people ) and Freddie Mac (nyse: FRE - news - people ), which also carries a government guarantee.

But investors should avoid Treasury bonds themselves because there will be $2.5 trillion more of them issued over the next year, El-Erian added. That’s on top of $6.0 trillion already outstanding.

Prices for most Treasury bonds fell Friday as stocks regained a little bit of the ground lost earlier this week. The yield on the benchmark 10-year Treasury rose to 2.88% from 2.82% on Thursday. A two-year Treasury yielded 0.93% at the end of Friday's session, up from 0.88%.

The iShares IBoxx $ Investment Grade Bond Fund (nyse: LQD - news - people ), a popular exchange-traded fund that invests in high-quality corporate debt, gained 20 cents, or 0.2%, to close at $93.10. That illustrates that interest rates fell in the corporate market while rising in Treasuries.

The commercial paper market is returning to normal after unprecedented steps by the government, the president of the New York Federal Reserve said Friday. Since late October, the central Federal Reserve has been buying commercial paper, short-term corporate debt, directly from companies after buyers fled the market following the collapse of Lehman Brothers (nyse: LEHMQ - news - people ) and a subsequent run on the money-market funds, which are ordinarily big buyers.

After an initial rush by companies to sell debt to the government at rates higher than normal, most corporate issuers have returned to selling at lower rates in the private market, William C. Dudley told a gathering of the Council on Foreign Relations. Government investment in commercial paper peaked at $350.0 billion in January and now stands at $250.0 billion.

After getting demolished by the financial crisis last year, the business of repackaging loans into bonds, should get a kick-start later this month when the government begins its Term Asset-Backed Security Loan Facility.

Under the TALF program, the Fed will lend money to investors who want to purchase bonds backed by credit-card, student, small-business and auto loans. The typical buyers of such asset-backed securities, banks and bank-run investment pools, disappeared from the market as worsening credit markets and losses in their own portfolios restricted their ability to buy new assets in the wake of the subprime mortgage crisis. That, in turn, has made it more expensive for borrowers who want to buy cars or take out credit cards, said Dudley. The TALF program could eventually include low-quality bonds that are now wreaking havoc on the balance sheets of many banks and other financial companies, he added.

Thomson Reuters contributed to this report.


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