Pacific Investment Management Co., the world's biggest bond fund, is cutting back its interest rate exposure in the United States and Britain, the fund said in a report on its outlook for 2010.
Managing Director Paul McCulley said the supply/demand balance for U.S. and British government debt was likely to suffer as governments stepped up borrowing, and as buying by central banks eventually declined.
"We're probably going to have a $1.4 trillion deficit this year without the Fed on the buy side of the market for duration," he said of U.S. Treasurys, in a report on Pimco's Web site.
"There is major uncertainty about how the supply/demand equation for duration will resolve itself when the Fed is out of the picture."
But Pimco remains "modestly bullish" towards interest rate exposure in the euro zone, which has not expanded fiscal policy so aggressively, and where central bank buying of longer-term debt will not shrink so much in 2010, McCulley added.
McCulley predicted sturdy growth in emerging market economies, slower growth in developed countries, and excessively low levels of inflation in the developed world because economies there still faced huge gaps between their actual and potential levels of output.
But he said economic forecasting had become more difficult in the past nine to 12 months as the global financial crisis had eased, making policy choices more complicated.
"Bottom line is that we have a very real possibility of a wide range of economic outcomes in the new year, and it's a dangerous game to maintain a religious devotion to any one in particular."
He added, "We're making a very active decision to run light on risk."
He also said, "At this point, we know this is not going to be a particularly high-yielding portfolio.
"You can only eat what's in the cafeteria, and right now the cafeteria doesn't have anything particularly appetizing in it." McCulley said Pimco, which has over $940 billion in assets, was becoming a bit more cautious about corporate debt.
The fund is now generally neutral versus its benchmark in this area, but still sees value in selected credits, especially in financials and non-cyclical sectors such as utilities and health care.
Pimco is underweight U.S. mortgage-backed securities, having cut its exposure as the U.S. central bank's buying tightened spreads, he said.
It is also underweight Treasury Inflation-Protected Securities on a tactical basis, since it believes risks are currently skewed towards disinflation.
The fund's currency target is "to be about 3 percent long a basket of emerging market currencies", while it favors emerging market sovereign credits and is expanding its positions in emerging market corporate bonds.
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