Bond managers unfazed by U.S. bear market

NEW YORK (Reuters) - Even into the eighth month of price declines in long-dated U.S. Treasury bonds, top investors are looking to add exposure on the bet the United States won't be facing inflation anytime soon.

Fund managers like Van Hoisington are putting money to work in the U.S. government bond market, skeptical of talk inflation is rearing its ugly head after government data showed the first global recession since World War II was easing.

"We think there is tremendous value at these levels in longer-maturing government bonds," said Hoisington, whose flagship Wasatch-Hoisington U.S. Treasury Fund (WHOSX.O) is down more than 20 percent this year after gaining 37.77 percent in 2008. "As a holder of bonds, we love them here at these levels and look to add more with new money."

A growing number of investors like Hoisington believe a lot of bad news has been priced into Treasuries and they are one of the most attractive long-term investments around.

They expect an anemic economic recovery to temper inflation, the main threat to bondholders as it erodes the value of returns on fixed-rate securities.

The United States' borrowing needs of $2 trillion -- or 14 percent of the country's total economic output and more than twice the record of 6 percent set in 1983 -- have kept the Treasury market under severe selling pressure this year.

The Lehman Brothers' U.S. Treasury Index of bonds maturing 20 years and more is posting negative returns of 22.37 percent. The yield on the 30-year bond is trading at 4.56 percent.

Treasuries have not been helped by rising risk appetite. Investors have scooped up beaten-up corporate bonds, whose yields had earlier risen close to double digits, in lieu of government securities. Yield-hungry investors poured a record $90 billion into U.S. bonds funds, mostly into taxable fixed-income funds like corporate debt, during the second quarter, according to Strategic Insight.

While longer-maturing government bonds have lost more than 22 percent year-to-date, investment-grade corporate bonds have posted total returns of over 11 percent. High-yield "junk" bonds have done even better: They've turned in returns of more than 35 percent, according to Merrill Lynch indexes.

WHO'S AFRAID OF THE FED?

Some fund managers like Tom Sowanick expect higher inflation and interest rate hikes by the U.S. Federal Reserve to undermine Treasury returns.

"The market is begging for the Federal Reserve to begin the unwind of quantitative easing," said Sowanick, chief investment officer at Clearbrook Partners in Princeton, New Jersey, adding that he would not touch Treasuries as a long-term investment.

But many others see U.S. Treasury debt prices turning attractive.

"Everything down the risk curve has rallied while Treasuries have done nothing but go down," said Dan Fuss, vice chairman of Loomis Sayles, which oversees more than $107.7 billion in assets. "I think Treasuries now look reasonably priced here relative to other assets."

Fuss, a fan of corporate debt, declined to say whether he'll start putting his money into public bonds, but added: "I am still bearish on the economy."

DEBT DEFLATION VS INFLATION

Keeping a lid on inflation are high U.S. consumer debt levels that have only just begun to come down, said Fuss and Hoisington.

The U.S. economy has become more leveraged as the recession progressed. Total U.S. private and public sector debt as a percent of GDP surged to 375 percent in the first quarter, a new post 1870 record, and well above the 360 percent average for 2008, Hoisington said.

An overleveraged economy is prone to deflation and stagnant growth, Hoisington argues.

In normal recessions since 1950, the low in inflation was, on average, 29 months after a complete economic recovery was under way, and bond yields moved in a similar fashion.

In this recession, with its high debt levels and shift of private resources to the public sector, it will take much longer for inflation to bottom out and investors to shorten maturities in Treasury portfolios, Hoisington said.

"The low in Treasury bond yields is a distant event," he said.

(Reporting by Jennifer Ablan; editing by Andrew Hay)