When the Big Dog Barks

Editor's Note: This column by Aaron Task, which traces the gyrations in the bond market caused in part by Pimco's hectic January trading, first appeared on TSC Feb. 3. The Wall Street Journal weighed in on the topic this morning.

The Great Bond Squeeze of Ought Ought

SAN FRANCISCO, Feb. 3, 2000 -- The

Nasdaq Composite Index

soared 137, or 3.4%,

today while the

Dow Jones Industrial Average

fought to close up 10.24, or 0.09%. Just another day at the office. Business as usual. Status quo. Right?

Wrong.

For while the stock market was dutifully following its "usual" routine, the bond market (which

everybody loves even more) enjoyed one of those once-in-a-millennium kind of moves. After being up more than 3 points at one juncture, the price of the 30-year Treasury bond finished up 2 1/32 to 99 28/32, its yield retreating to 6.14%. To put that into perspective, five years ago anything more than a 1/2-point move in the long bond was considered

huge

.

But that was then, and this is now.

The story today was all about market players caught shorting the long end of the

yield curve and being forced to cover as the 30-year rallied sharply in the wake of the

Treasury Department's

refunding announcement yesterday. (The short-covering, of course, exacerbated the

rally.)

Early on, the rumor

du jour

was a retread of last

Friday's -- specifically, that a "West Coast hedge fund" was facing big losses from being short long-dated Treasuries and long mortgage-backeds and other "spread" product. By midmorning, rumors circulated that some Wall Street firms exposed to the same trades were having an "emergency meeting" with the

New York Federal Reserve

because the potential losses were so debilitating.

Stocks swooned on the rumor in the a.m. and then soared -- especially techs -- after around 12.30 p.m. EST, when the N.Y. Fed said the rumor was "completely unfounded." (Then again, the N.Y. Fed wasn't terribly forthcoming during the

Long Term Capital Management

crisis.)

"I believe people are losing a lot of money --

fixed-income markets don't behave like this when people get it right," said one bond trader who requested anonymity. "Every

primary dealer has to put up $50 million in capital

$100 million for commercial banks, and you can lose that because you make trading mistakes. But what's the emergency? That you're not going to Hawaii this year with your wife?"

The trader claimed no personal knowledge about the N.Y. Fed rumor, but "because they did this thing with Long Term Capital, people think anything is possible." (

Moral hazard, anyone?)

(FYI,

Lehman Brothers

(LEH)

,

Citigroup

(C) - Get Report

and

Donaldson Lufkin & Jenrette

(DLJ)

denied they were facing big losses while

Goldman Sachs

(GS) - Get Report

and

Bank of America

(BAC) - Get Report

declined to comment, according to a report by

Dow Jones

.)

As the day progressed and the rumor mill subsided, some "facts" came to light. (I use the quotations because, unfortunately, none of this is 100% verifiable.)

First, note that in Wall Street-speak, "West Coast hedge fund" or "West Coast money manager" is often (if not always) a euphemism for

Pacific Investment Management Co.

, a.k.a. "Pimco." Led by bond guru (and frequent

CNBC

guest)

Bill Gross

, the Newport Beach, Calif., investment-management firm oversees something like $186 billion -- and is one of the biggest fixed-income houses in

todo el mundo

.

"The story is, Pimco came in to a couple of big dealers and sold spread-type product and bought zeros or bonds last week," the bond trader said. Specifically, Pimco sold $10 billion worth of mortgage-backed securities and some agency debt last Friday, according to other sources. A Pimco spokesman declined to comment.

When the mortgage-backeds and other spread product turned sour this week as the Treasury market rallied, the broker/dealer community was then left holding the proverbial bag (as in airsickness).

The rumors strike me as plausible because Pimco is a "big customer and a high-priority account" and the "

masters of the universe don't shy away from size," the bond trader said. "They should have said, 'We'll pass on this deal,' but Bill Gross is smart. He took advantage."

Reality Check

Let's step back a minute to recall that all this chatter about Pimco (and others) is an effect of the bigger issue -- the "disappearance" of the supply of 30-year bonds -- and not the cause.

But while the Treasury's announcement yesterday certainly roiled markets, "none of this stuff is particularly shocking," the trader said.

Indeed, lessening the supply of 30-year bonds has been a hallmark of

Lawrence Summers'

tenure as Treasury secretary -- at least since

early August.

So while most market players were focused on Y2K and then the

Fed

, the trader said the so-called smart-money players were buying Treasuries in front of the government.

Sound fanciful?

"In mid-January, Pimco and several other money managers began to shift their curve strategies ... to something closer to a 'barbell,' consisting of lots of long-term Treasuries and cash. The idea, in part, was simple: Beat the Treasury to the punch by purchasing the exact issues that they were going to buy a few months later."

The rantings of some crazed conspiracy theorist?

No, they're directly from Bill Gross's own

commentary today at Pimco's Web site.

Mel Brooks

was right -- it's good to be the king.

--

Staff reporter Erin Arvedlund contributed to this column.

Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He welcomes your feedback at

taskmaster@thestreet.com.