UPDATE 2-PIMCO: Fed to 'engage again' in Treasury buys

(Adds El-Erian on dollar, investment opportunities)

NEW YORK, June 12 (Reuters) - The rapid rise in bond yields will force the Federal Reserve to “engage again” in the purchases of U.S. Treasuries and mortgage-backed securities, Mohamed El-Erian, the chief executive of bond giant Pacific Investment Management Co., said Friday.

The surge in Treasury yields is lifting mortgage rates, threatening to dampen home demand and kill off the refinancing boom that is bolstering the health of some households.

“What mistake can the U.S. economy afford to make? If you look at it that way, I suspect that we will see the Fed engage again in these markets,” El-Erian, who oversees $756 billion at PIMCO, told Reuters Financial Television.

Debate is brewing within the Federal Reserve over whether it should ramp up its purchases of Treasuries and mortgage-backed securities to keep a lid on interest rates, or scale them back to avoid an outbreak of inflation.

Massive buying of securities by the U.S. central bank has doubled the size of its balance sheet to around $2 trillion as it flooded the economy with money to prevent a severe recession getting worse.

The Fed’s Open Market Committee voted unanimously in April to keep unchanged its targets for purchases of MBS and long-term Treasuries. But the panel left the door open to increasing purchases at future meetings if needed to secure a stronger recovery, according to minutes of the meeting. The FOMC next meets on June 23-24 in Washington.


Investors’ fears in the United States and abroad are rising about the health of America’s economy, owing to its need to borrow for stimulus programs. That will keep the U.S. dollar under pressure, El-Erian said. “We could be embarking on a multiyear process of erosion, at the margin, of the global standing of the U.S.”

The United States faces competition also from Brazil, Russia, India and China, which account for 15 percent of the $60.7 trillion global economy. El-Erian said the so-called BRIC nations, which are meeting next week for their first formal summit, are increasingly pressing the case for “a larger role on the global stage, as they should.”

High-yield "junk bonds" and equities are also vulnerable, El-Erian added. As an example, the roughly 40 percent rise in the Standard & Poor's 500 index .SPX since early March has been "excessive" and not supported by economic fundamentals, he said. "The last part of the rally in a lot of risk assets ... was exaggerated" by hedge funds and fund managers chasing performance, he added.

El-Erian said PIMCO has been a buyer of high-quality corporate bonds and short-maturing government bonds in the United States and abroad, arguing economies still face major headwinds including a fragile labor market. He expects the unemployment rate in the United States to reach between 10 percent and 10 1/2 percent.

“Over the immediate next few weeks, we think Treasuries at this point had oversold, particularly front end of curves around the world had oversold,” El-Erian said. “We do not believe the Fed, European Central Bank or the Bank of England will be hiking rates any time soon. We have found value in the front end of the curve.” (Reporting by Jennifer Ablan and Daniel Burns; Editing by Kenneth Barry)