BOSTON ( TheStreet) -- The last-minute U.S. debt-ceiling resolution and the still-unresolved issues that go with it has cast a pall over the nation's once pristine Treasury bonds. Most spectacularly, the government bonds may lose their triple-A credit rating.Investors are reacting by pulling out of investments that are heavy on short-term Treasuries, in particular money-market funds, and piling into sovereign debt and equities in countries with strong economies such as Germany as well as some emerging markets.
Jeff Tjornehoj, a senior research analyst at Lipper, said he's heard anecdotally that a lot of bond fund managers aren't making wholesale shifts in their portfolios as they're waiting to see what plays out on Capitol Hill in the coming weeks as Congress negotiates new taxes and spending cuts and votes on the debt-ceiling limit deal. But yields on the long end of Treasuries -- 10-year and 30-year bonds -- have fallen in anticipation of slower economic growth, he said. The 10-year note's yield is the lowest since Nov. 12, 2010. "Most of that movement came in response to the first quarter's GDP (gross domestic product) being revised down so sharply." The Commerce Department last Friday said first-quarter growth was slower than originally reported, coming to an almost standstill rate of 0.4% from its previously reported 1.9%. The government also reported that second-quarter GDP grew at a snail's pace of 1.3%. "Now we've seen two quarters of anemic growth behind us, so this appears to be an extremely slow (economic) recovery," said Tjornehoj. Todd Rosenbluth, a mutual fund analyst with S&P Equity Research, said the prospect of a downgrade still has many investors rattled "as it would raise the risk profile of all bond funds. For some people, that modestly higher level of risk could be too much" and prompt them to shuffle their portfolios. Some fund managers may have already changed their allocations in anticipation of events, while others may decide just to see it through and maintain the structure of their current portfolio, Rosenbluth said. But Brandt said that the outflows from money market funds are likely to continue "after a pause while people digest what is happening." He said his firm is seeing steady flows into stronger economies worldwide. For example, German equity funds have seen inflows of more than $15 billion this year, three times that of the $5.5 billion that has gone into U.S. equity funds. Funds investing in emerging-market debt also extended their streak of money inflows to 18 weeks, and commodity sector funds specializing in gold and precious metals took in over $1 billion for the third week straight, the firm said. Legendary bond fund manager Bill Gross, who heads the $243 billion Pimco Total Return Fund ( PTTAX), garnered lots of publicity earlier this year for taking a "short" position in Treasuries, after a tremendous rally in that market, but has been tip-toeing back into Treasuries, perhaps on expectations of continued economic weakness. During the second quarter, he raised his Treasury and Treasury-related securities holdings in the Total Return Fund to 9% from 4% at the end of the first quarter, according to a summary of fund holdings posted on the company's Web site. The fund also increased its stake in non-U.S. developed and emerging-market debt to 24% from 16%. Brazil was the leading foreign holding.