Dan Fuss, whose Loomis Sayles Bond Fund beat 95 percent of competitors in the past year, says Bill Gross got it right by forecasting declines for U.S. Treasuries.

U.S. 10-year yields will rise past 4 percent next year as the government sells record amounts of debt, from 3.86 percent today, Fuss said in an interview from Tokyo on Bloomberg Television. “Bonds have seen their best days,” Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., said last week on Bloomberg Radio.

“I agree with what Bill is saying but I don’t go to the degree that he does,” Fuss said. “I do think very strongly that we will soon see -- soon being next year sometime -- the start of a long, gradual rise in interest rates in the U.S. and in other parts of the world.”

Treasuries headed for their first monthly loss this year on concern President Barack Obama’s attempts to sustain economic growth by borrowing unprecedented amounts will overwhelm demand. The U.S. can’t ignore the effect of the growing federal deficit on Treasury yields, Federal Reserve Bank of Dallas President Richard Fisher said yesterday.....

Even as prospects for the American economy brighten, consumers are about to face a new financial burden: a sustained period of rising interest rates.

That, economists say, is the inevitable outcome of the nation’s ballooning debt and the renewed prospect of inflation as the economy recovers from the depths of the recent recession.

The shift is sure to come as a shock to consumers whose spending habits were shaped by a historic 30-year decline in the cost of borrowing.

The impact of higher rates is likely to be felt first in the housing market, which has only recently begun to rebound from a deep slump.....

May 27 (Bloomberg) -- Dan Fuss, whose Loomis Sayles Bond Fund beat 95 percent of competitors the past year, said he sold all of his Treasury holdings because of prospects interest rates will rise as the U.S. borrows unprecedented amounts.

“The fundamentals are awful,” Fuss said in a telephone interview yesterday from Boston. “The incremental borrower of funds in the U.S. capital markets is rapidly becoming the U.S. Treasury. Do you really want to buy the debt of the biggest issuer?”

Fuss said he doesn’t own Treasuries in any of the investments he is directly involved with after selling the last of them this week. Loomis Sayles cut the securities to the lowest possible amount in funds with liquidity requirements or a minimum mandated level of U.S. government debt, he said.

His comments echo those of Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co. and warned in his investment outlook for June that the U.S. is in a “debt super cycle.” Moody’s Investors Service said this week the U.S.’s top bond rating will come under pressure unless the government takes steps to reduce projected record budget deficits.....

A week ago at the CFA Institute's 2010 Annual Dinner, Baupost's Seth Klarman stole the spotlight by announcing to everyone that he was "more worried about the world than ever" while making it clear that he was on the same Jim Grant and Julian Robertson "Treasury put" bandwagon. Yet another speaker present at the event, who undeservedly received much less attention, was CLSA'a Russell Napier, who has long been warning about precisely the thing that all asset managers are realizing rather belatedly, that Treasuries are a very "fundamental asset bubble." The only relevant questions, which Napier has previously discussed extensively, are "when do treasuries crash" and "what do you do" when that happens. The attached presentation provides some color on both.

Russell Napier, whose Anatomy of the Bear (available for a pdf-special $3.95 steal on DocStoc) is one of the better market analysis books available, had one quite insightful observation. As the CFA noted in its press release on the matter, "One point that Mr. Napier made toward the end of his presentation was that the difference between current borrowing and previous peaks in government debt is that previous surges in the debt load were linked with the financing of conflict. As he put it, the current borrowing is to keep people alive rather than to kill. The implication for the global economy of this key difference is that social programs to subsidize a certain quality of life are not a profit-making endeavor in the same way as traditional twentieth century conflicts." We wish we were as sanguine about this conclusion as Mr. Napier. With a rapidly deteriorating geopolitical situation in both the Middle and Far East, perhaps the massive entitlement spending has been nothing short of a diversion from the the traditionally massive "defense" spending. After all, there have been over $257 billion in defense vendor payments by the US Treasury since October, an outlay smaller only than Social Security Outlays and Medicare.

And since Napier's perspective has been largely ignored by the Mainstream media, we provide a link to his most recent comprehensive presentation on the topic of the Treasury bubble from earlier this year. In it, Napier takes (apriori) on a point made last week by Albert Edwards, an states that "balance of payments is key, not current account" pointing out that bigger CA deficits do not necessarily mean falling reserves as can be seen in the Thailand case, leading him to conclude that "Asian reserves will grow as capital flows reverse." Furthermore, back in February, Napier predicted perfectly the most recent TIC data which showed a record foreign capital flow into US securities (whether this was predicated by the capital flight ouf of Europe is largely irrelevant). Napier also questions the role of US commercial banks, and is confident they can plug a hole of up to $1 trillion in Treasury demand, saying "bank purchases of government debt can reflate America" in one of the most vicious Catch 22s, since the Fed funds banks at the discount window with money used to subsequently purchase safe assets, thereby monetizing debt with one small step of separation, a topic long discussed by Zero Hedge. Another key point is the recently notable observation on the plunging M3 via Ambrose Evans-Pritchard - as Napier shows this is certainly not the first time that broad money supply has contracted and led to lower inflation. The real question is what happens to credit demand in a disinflationary phase, all else equal, which however thanks to Europe, will not be the case for a long time.

Lastly, the Asian expert analyzes the role of governments, and specifically those of Asia and China as a preamble to the great Treasury bubble pop:

China’s return to gradual appreciation of the renminbi does not stop funds pouring into Treasuries
A one-off revaluation was not spurred by 8% inflation in China in 2008 so it will not happen now
Capital controls are coming in Asia
Capital controls will be insufficient and credit controls will follow
Such measures shorten the duration of the great distortion but still current due to CA surpluses
While Napier does not provide the ever-elusive answer on when to expect the bubble pop, his insights give some more variables to juggle as we all await the bursting of the greatest bubble in capital markets history.

June 14 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke has tamed the bond vigilantes.

While investors punish European nations from Greece to Spain for deficits by pushing up bond yields, Treasury rates of all maturities have fallen to an average of about 2 percent from 2.75 percent a year ago even as the amount of marketable debt outstanding increased 20 percent to $7.96 trillion.

The market’s advocates of fiscal discipline are being placated as Bernanke keeps benchmark interest rates at a record low, allowing them to profit from the gap between short- and long-term yields with inflation at a four-decade low. Bill Gross, the manager of the world’s biggest bond fund, said as recently as March that “bonds have seen their best days.” On June 4, he called Treasuries “attractive.”

“Central banks by keeping rates near zero have basically covered the bond vigilantes in duct tape,” said Edward Yardeni, who coined the term in 1983 for investors who protest inflationary monetary or fiscal policies by selling bonds and driving up government borrowing costs.....

By ALAN GREENSPAN

An urgency to rein in budget deficits seems to be gaining some traction among American lawmakers. If so, it is none too soon. Perceptions of a large U.S. borrowing capacity are misleading.

Despite the surge in federal debt to the public during the past 18 months—to $8.6 trillion from $5.5 trillion—inflation and long-term interest rates, the typical symptoms of fiscal excess, have remained remarkably subdued. This is regrettable, because it is fostering a sense of complacency that can have dire consequences.

The roots of the apparent debt market calm are clear enough. The financial crisis, triggered by the unexpected default of Lehman Brothers in September 2008, created a collapse in global demand that engendered a high degree of deflationary slack in our economy. The very large contraction of private financing demand freed private saving to finance the explosion of federal debt. Although our financial institutions have recovered perceptibly and returned to a degree of solvency, banks, pending a significant increase in capital, remain reluctant to lend.

Beneath the calm, there are market signals that do not bode well for the future. For generations there had been a large buffer between the borrowing capacity of the U.S. government and the level of its debt to the public. But in the aftermath of the Lehman Brothers collapse, that gap began to narrow rapidly. Federal debt to the public rose to 59% of GDP by mid-June 2010 from 38% in September 2008. How much borrowing leeway at current interest rates remains for U.S. Treasury financing is highly uncertain.

The U.S. government can create dollars at will to meet any obligation, and it will doubtless continue to do so. U.S. Treasurys are thus free of credit risk. But they are not free of interest rate risk. If Treasury net debt issuance were to double overnight, for example, newly issued Treasury securities would continue free of credit risk, but the Treasury would have to pay much higher interest rates to market its newly issued securities.....

Bond investors seeking top-rated securities face fewer alternatives to Treasuries, allowing President Barack Obama to sell unprecedented sums of debt at ever lower rates to finance a $1.47 trillion deficit.

While net issuance of Treasuries will rise by $1.2 trillion this year, the net supply of corporate bonds, mortgage-backed securities and debt tied to consumer loans may recede by $1.3 trillion, according to Jeffrey Rosenberg, a fixed-income strategist at Bank of America Merrill Lynch in New York.

Shrinking credit markets help explain why some Treasury yields are at record lows even after the amount of marketable government debt outstanding increased by 21 percent from a year earlier to $8.18 trillion. Last week, the U.S. government auctioned $34 billion of three-year notes at a yield of 0.844 percent, the lowest ever for that maturity.....

The amount of money flowing into bond funds is poised to exceed the cash that went into stock funds during the internet bubble, stoking concern that fixed- income markets are headed for a fall.

Investors poured $480.2 billion into mutual funds that focus on debt in the two years ending June, compared with the $496.9 billion received by equity funds from 1999 to 2000, according to data compiled by Bloomberg and the Washington-based Investment Company Institute.

Concern that the global economic recovery is faltering, with the U.S. growing at a slower-than-forecast 2.4 percent pace in the second quarter, is prompting investors to pile into fixed-income securities of all types even with some yields at record lows. The new cash has helped fuel a rally and drove yields on investment-grade U.S. corporate debt down to a record 3.79 percent last week, while two-year U.S. Treasury yields fell to an all-time low of less than 0.5 percent.....

Much has been made lately of a possible bubble in bonds. The rapid decline in Treasury yields could certainly be taken for evidence of overexuberance. The fact that we are seeing bonds rally up and down the credit spectrum adds to concerns about the existence of a fear-driven rally in fixed income.

Market analysts are also fretting about the level of investment capital inflows (much of it from domestic sources) to the credit markets, relative to net withdrawals from equities, and the effect of the Federal Reserve’s announcement that it would be redeploying billions of dollars from its existing mortgage bond positions to support the Treasury market and ensure low yields.

Nevertheless, for all the support the bond market is receiving from the prevailing mix of panic and policy, the fact remains that there is no perceptible increased demand for capital sufficient to offset the rather small flow of new issuance in the government and corporate fixed-income markets.

The lack of demand for money has been signaled by the bond market all year — even back when the “V-shaped” recovery crowd was misinterpreting short-term surges in economic activity.....

Five months ago Bill Gross, who runs the world’s biggest mutual fund at Pacific Investment Management Co., declared that the 30-year bull market in fixed-income securities was over.

Nobody questioned him. After all, Gross’s Pimco Total Return Fund has been successful enough to attract $239 billion.

No one paid much attention either.

Since Gross uttered his warning, U.S. government and corporate bonds have remained in demand. The yield on the benchmark 10-year U.S. Treasury note has dropped to about 2.5 percent from 3.9 percent in late March.

Rising prices of the government’s debt helped investors in all Treasuries earn a return of 4.7 percent in the second quarter and another half percent in July, according to an index by Bank of America Merrill Lynch.

While Gross may be right for the long run, recent headlines have accelerated the bull run in bonds......

Like a drunk at a party, the bond market is starting to bump into tables, telling off-color jokes, talking too loudly and spilling drinks. The smart guests will steer clear before he starts screaming at his shoes and wanders off to pray to the porcelain.

Did you think a 950 billion-euro ($1.2 trillion) emergency backstop cobbled together by the European Union and the International Monetary Fund in May was the answer to Europe’s debt crisis? Were you expecting central banks to turn off the money taps as normal funding service resumed in the banking industry? Had you hoped the heavy hand of government would only briefly slide its interfering digits into the folds of finance?

Ireland, which proudly brewed its own flavor of austerity medicine and swallowed the potion without demanding so much as a spoonful of sugar, now pays a record 3.8 percentage points more than Germany to borrow 10-year money. Spreads on Greek debt, which triggered the crisis by revealing that it forged its euro- membership qualifications and lied ever since, have surged to 9.5 points, a whisker away from a record.

The U.S. and Germany, meantime, are enjoying the cheapest borrowing costs they have ever had. That schizophrenia follows a pattern seen before during this credit crisis, with an endgame that is all too predictable.

First, the allegedly good banks were distinguished from the undoubtedly toxic ones -- until they all turned out to be as bad as each other. Next, the financial system was perceived to have been rescued by governments -- until the cold sting of logic pointed out that risk was being transferred, not dissolved.....