Pimco to cut exposure to long-dated US debt as deficits swell

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Pimco has become more hesitant to buy long-term American government debt as the $2tn US bond fund manager frets over “sustainability questions” and the prospect of rising inflation under Donald Trump.

The bond giant said in a note on Monday that it was cutting its exposure to long-dated US debt because of what it termed deteriorating deficit dynamics, instead favouring shorter-term notes “where investors can find attractive yields without taking greater interest rate risk”.

Pimco’s chief investment officer of non-traditional strategies Marc Seidner and portfolio manager Pramol Dhawan are expecting US debt levels to keep rising from already high levels. The US federal budget deficit reached $1.8tn for the fiscal year ending September 30, up 8 per cent from the previous year.

Any further increase would, Seidner and Dhawan said, put greater pressure on longer-dated bonds, which are more sensitive to changes in interest rate changes — sending yields even higher.

As the world’s biggest active bond fund manager, Pimco’s allocation decisions are scrutinised closely because of their potential to trigger changes in valuations across global financial markets. Investors are also increasingly watching for signs of “bond vigilantism” to emerge as the US government increases its borrowing, referring to a scenario whereby debt-owners push back against new issuance by selling down their positions.

“There is no organised group of vigilantes poised to act at a specific debt threshold; shifts in investor behaviour typically occur at the margin and over time,” Pimco wrote on Monday. “If you’re seeking clues about the potential for bond vigilantism, you might start by asking the largest fixed income investors — who theoretically hold the most market sway — what they’re doing.”

In a sign of worries already seeping through the $27tn US government debt market, the 10-year Treasury yield jumped significantly in October and early November as traders raised bets that Trump would win the US election — predicting the next administration’s plans for trade tariffs and corporate tax cuts would fuel inflation and expand America’s debt load.

The benchmark yield traded at 4.19 per cent on Monday, lower than the highs scaled immediately after Trump’s victory early last month but still significantly above its 3.8 per cent level in late September.

Noting that US gross national debt had just reached $36tn, the Committee for a Responsible Federal Budget said late last month that “rising debt poses serious domestic and geopolitical risks: it slows our economy, threatens higher inflation and interest rates, and squeezes our budget through higher interest rates”. The CRFB said debt was on track for an all-time record share of the economy in two years, with interest payments expected to cost $13tn over the next decade.

Pimco also said on Monday that it was looking beyond US shores to diversify its bond exposure and achieve higher returns. Seidner and Dhawan pointed specifically to the UK and Australia as examples of “high-quality sovereign issuers with stronger fiscal positions than the US”, while noting that higher economic risks in those countries could also generate stronger yields.

The bond behemoth conceded the US dollar was still the global reserve currency, and the Treasury market is the bedrock of the financial system. However, Pimco said, uncertainty would continue to grow as debt keeps rising, and “if you borrow too much, lenders may question your ability to pay it all back”.