IFR-After PIMCO's US Treasuries purge, look for curve flatteners

Wed Mar 9, 2011 9:44pm EST

-- Courtney Drake is a Fixed Income Analyst and Kenneth Logan is the Global Managing Analyst, Rates at IFR Markets. The views expressed are their own. --

By Courtney Drake and Kenneth Logan

BOSTON, March 10 (IFR) - PIMCO's Total Return Fund, the world's largest bond portfolio, unloaded all of its remaining U.S. Government-related holdings in February. The fund's Treasury holdings' recent peak was back in June 2010 at 63% to then steadily fall since to where they are now slashed to 0% from 12% ($28.6 bln) in February. Certainly a statement of first a vote of no confidence in the U.S. budget situation but also an indictment of the current artificial low interest environment.

In the latest report, which was "leaked" to the blog Zero Hedge, net cash and equivalents rose to 23% from just 5% in January. The cash was raised through the sale of their treasury holding, but also as the fund lowered its holdings of mortgage-backed securities from 42% to 35% on the month.

The fund increased its holdings in the front end (maturities up to 1 year) to 14%, up from 0% in January. Holdings in the 1- to 3-year sector fell to 31% vs. 35% in January, holdings in the 3- to 5-year sector fell slightly to 25% vs. 26%, holdings in the 5- to 10-year sector fell to 26% vs. 32%, holdings in the 10- to 20-year sector fell to 3% vs. 5%, and holdings in the 20+ year sector fell to 1% vs. 2%.

In this duration shedding process, the average duration of the fund fell to 3.89 years (smallest since December 2008) vs. 4.42 in January, and the average maturity fell to 5.38 years from 6.13.

The fund's assets fell about $1.6 bln over the month to $236.9 bln with much of this leakage likely due to principle loss as they sold into a declining market. Hard to say for sure, but in a bit of a forensic analysis it appears that PIMCO likely sold the bulk of this duration during the first week of February when yields somewhat inexplicably shot higher -- 3.33% to 3.55% in the 10-year -- going into the February 4 payroll print -- rates peaked on February 8 and 9th just north of 3.75% on 10s.

As we said at the end of January when PIMCO began its duration purge to raise cash; "from a contrarian point of view, now that the fund has already experienced a run out of duration and have built up a positive cash position suggesting at least it is unlikely that their future market moves will weigh more, if at all, on the market with the better intimation being that they have now become a potential better buyer at the right price."

Right now we'd say that PIMCO has well made its bearish bed, a position that we well sympathize with, but something that they will likely need to have the patience of a Saint to sleep well through.

We'll say a prayer for ya Billy. In the meantime we'll skip over to the buy the dip camp as well as better ply the curve flattening trade of owning 7s and 10s against the 3-year. We'll enter a WI3s/WI10s flattener at 225.1 bps (1.222% and 3.473%).