Pimco cut its holdings of Japanese and U.S. government debt in the past six months due to their diminishing investment appeal, although Japan's political turmoil is unlikely to trigger a spike in yields in the near term, the top bond fund's head of Japan portfolio management said.
Tomoya Masanao also said a default on U.S. Treasuries would cause quite a big shock to global markets, although he expects the country to eventually avoid this from happening.
Japanese Prime Minister Naoto Kan survived a no-confidence vote in parliament last week by saying he would quit. But he did not specify when, and the political impasse has raised concerns of delays in fiscal reforms to rein in the country's huge public debt, which is twice the size of its $5 trillion economy.
The huge cost of reconstruction from the March 11 earthquake and tsunami adds to the fiscal burden, triggering threats of credit downgrades by rating agencies.
Pimco has slightly cut it holdings of Japanese government bonds since December last year but from a valuation standpoint rather than on concerns about the country's fiscal and political woes, Masanao said.
The political outlook is hard to predict and hard to interpret as a market theme, Masanao said.
The main driver of underlying market moves is the outlook for the global economy rather than Japan's fiscal policy, he told Reuters in an interview on Thursday.
Along with a cut in JGB holdings, Pimco also significantly reduced investment in U.S. Treasuries in the past six months, Masanao said.
The move is aimed at shifting money to more attractive investment opportunities, such as debt issued by countries like Australia, Canada, Brazil and Mexico which are not faced with serious fiscal problems, he said.
Based in Newport Beach, California, Pacific Investment Management Company (PIMCO) is the world's largest bond fund manager with nearly $1.3 trillion in assets under management.
GLOBAL SOFT PATCH LIKELY
Masanao said the risk of the global economy experiencing a soft patch was heightening, casting doubt on the Bank of Japan's forecast that the Japanese economy will resume a moderate recovery by the end of this year.
Japan's economy may suffer another slump on weak demand if fiscal stimulus is too little and too late, or if expectations of prolonged monetary easing by the Federal Reserve trigger a spike in the yen against the dollar, he said.
The key will be whether the BOJ eases monetary policy pre-emptively, Masanao said.
Unfortunately, the BOJ's past behavior had been reactive, not proactive, he said. What it should do is to aggressively buy JGBs, effectively adopting quantitative easing, to curb yen rises.
The 9.0 magnitude quake and a deadly tsunami that struck Japan's northeast left around 24,000 dead or missing and triggered the world's worst nuclear crisis in 25 years, pushing Japan into its second recession in less than three years.
The BOJ eased monetary policy just days after the earthquake. It has stood pat since then on the view the economy will resume a moderate recovery before the end of the year, fueled in part by reconstruction.
The central bank has signaled that it stands ready to loosen policy further if the damage from the quake proves greater than expected and hits domestic demand.
But it opposes reverting to full-blown quantitative easing and is cautious of boosting purchases of long-term JGBs for fear of giving markets the impression it is monetizing government debt.
(Additional reporting by Takaya Yamaguchi and Daiki Iga; Editing by Michael Watson)