By MARY PILON And MARK GONGLOFF
Two of the biggest fund managers in the world are at odds over how U.S. government securities will fare once the Federal Reserve withdraws from the bond market in June, marking the end of its second quantitative-easing program, or QE2. Their disagreement is symptomatic of a larger debate gripping the bond market and the rest of Wall Street: What will happen when the Fed turns off the tap?
Mr. Gross, who oversees Pacific Investment Management Co.'s $1.2 trillion in assets under management, has been vocal about his views that the end of the Fed's $600 billion program is bad for bonds. He argues that the absence of such a large buyer means Treasury prices are likely to fall, pushing rates higher.
"When QE2 ends in June, then $1.5 trillion worth of check-writing per year basically disappears," Mr. Gross said in a recent interview. "It will be a big event."
Pimco is a unit of Allianz (ALVG.DE)
Mr. Rieder, chief investment officer, fundamental fixed income, at BlackRock Inc., with $1.58 trillion in fixed-income assets, sees the Fed's exit as far more benign.
He says the Treasury market has known for several months that QE2 will end and has had plenty of time to prepare, meaning QE2's actual end will have little effect on yields. And Treasurys might even gain, sending rates lower, if the end of QE2 causes stocks and other assets to fall.
"Any market concern over liquidity, or increased volatility, tends to benefit Treasurys as they are still considered to be the flight-to-quality asset," Mr. Rieder says. If interest rates do drift up, it will be modest and gradual, Mr. Rieder says.
The two fund managers publicize their views far differently: Mr. Gross isn't shy about appearing in the media or sharing his thoughts in monthly missives, likening Congress to skunks and ratings firms to hookers. While Mr. Rieder's television appearances are rarer, he is a fixture on BlackRock's trading floor, and his monthly calls attract 300 to 500 BlackRock employees. Regardless of their styles, both hold sway, even in the $9 trillion government-bond market. Their moves are widely followed and mimicked by other investors.
Mr. Rieder said BlackRock has been buying Treasurys and will step in again if rates move higher; he considers 3.75% on the 10-year note a possible buying opportunity. The BlackRock Total Return Fund he co-manages has returned 7.25% in the last year, according to Morningstar Inc.
Mr. Gross has been betting against government securities in his flagship, $237 billion Total Return (pttrx)
The 10-year note's yield has already risen to 3.4%, from 2.62% on the day QE2 was announced last November. Thirty-year mortgage rates, which track 10-year note yields closely, have risen to 4.8% from 4.24% last November, doing little to help a struggling housing market.
The direction of interest rates after the Fed ends its bond-buying program is crucial for the economy. The issue will be in sharp focus this week, when Fed policy makers hold a two-day policy meeting, starting Tuesday, to discuss their efforts to steer the economy between the shoals of recession and inflation.
They face an economy that has shown signs of losing momentum in recent months, with first-quarter economic growth now widely believed to be less than 2% annualized. At the same time, soaring commodity prices have raised inflation alarms. The spread between short-term and long-term interest rates has widened, and demand for inflation-protected securities has picked up, suggesting inflation concern is rising among investors.
The Fed's policy makers this week will likely vow to stick to their plan to end the purchases of Treasurys by the end of June.
But that's where the certainty ends.
One yardstick for the immediate future of Treasury yields after QE2 could be QE1, which included a $1.25 trillion Fed buying spree of mortgage bonds from late 2008 to March 2010.
The mortgage-bond market felt barely a ripple when the Fed stopped buying. Treasurys, some observers reason, may follow the same path.
Treasury yields "moved up significantly at the onset of QE1 but then fell precipitously when it ended," Mr. Rieder says. "So it's not a given that Treasury yields will rise this time either."
The New York Fed, which operates the QE2 program, declined to comment.
What worries some is that the Fed has been buying almost all of the Treasurys the government has been issuing on a regular basis.
So far the Fed has bought $548 billion worth of Treasurys under QE2, according to a Barclays Capital tally, with maturities ranging from 1 to 30 years, and inflation-protected securities as well. The buying has made up more than 85% of the net $638 billion of bonds the government sold between November and March.—Min Zeng
contributed to this article.