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Wednesday, July 14, 2010 / Capital Markets - Pimco caught out by strength of gilts

Pimco caught out by strength of gilts

By David Oakley, Capital Markets Correspondent
Published: July 14 2010 10:57 | Last updated: July 14 2010 10:57

Pimco, the world’s second-biggest bond fund manager, has backtracked on its aggressive position of selling UK government bonds after the impressive performance of the gilts market this year.

Pimco, which took a negative view on the UK last year because of the widening budget deficit and poor public finances, has switched its stance to neutral or “agnostic” on gilts, according to people familiar with the situation.

Bill Gross, co-head of Pimco, in January described the UK government bond markets as so volatile that they were “resting on a bed of nitroglycerine”.

At the time, most investors feared that the worsening public finances and the uncertain political outlook before the general election in May would spark a big sell-off in prices.

However, the reverse has happened. Gilts have been one of the best-performing government bond markets of the year, becoming a haven from the troubles in the eurozone in recent months.

Gilt yields, which have an inverse relationship with prices, have fallen more than 20 per cent to 3.39 per cent since this year’s peak of 4.27 per cent on February 19.

Gilts have mainly been buoyed by buying of international investors, particularly Asian funds that switched out of peripheral eurozone bonds as the eurozone debt crisis deepened.

Investors have also been reassured by the new pact between the Conservatives and Liberal Democrats following the deadlocked May general election that produced a hung parliament. The Con-Lib pact’s promise to tighten fiscal policy sharply over the next five years has improved sentiment and even eased fears that the UK might lose its prized triple A credit rating.

Most investors have changed their forecasts for the gilts market in recent months, with some even saying gilt yields could fall further amid ongoing worries over European bank stress tests and the peripheral eurozone economies.

Pimco were not outright sellers of gilts, but set up a relative trade against Bunds, which fund managers say has been profitable.

Gilts have on occasion outperformed German bonds – but since the start of the year Bund yields have fallen more than those of gilts. Ten-year gilt yields have fallen 16 per cent while Bund yields have dropped 20 per cent.

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