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By Jason Stipp | 11-16-2011 12:00 AM

PIMCO Unconstrained's Dialynas on Interest Rate Expectations

An eventual interest rate rise could occur in a relatively benign growth environment, and may happen rather quickly, says PIMCO Unconstrained Bond's Chris Dialynas.

Jason Stipp: I'm Jason Stipp for Morningstar. Investors have been focused on the equity markets as volatility has taken the markets up and down recently, but we also know that fixed-income markets have been very difficult for investors.

We're checking in today with Chris Dialynas. He is a manager on PIMCO Unconstrained. This fund has a flexible mandate to avoid trouble spots and seek out opportunities.

We're going to find out how he's positioned today. Chris, thanks for calling in.

Chris Dialynas: Thank you.

Stipp: First question for you, Chris. We know that there seem to be what we perceive as countervailing forces in the fixed-income market. So we have many managers positioning for what they expect will ultimately be a rising interest rate environment. At the same time we see that investors will, during times of market shocks, pile back into Treasuries and seek that flight to safety.

So, I'm wondering if you can talk about how you're managing in an environment where we're seeing these seemingly counter forces at work.

Dialynas: You're right. There are some countervailing forces at work with respect to the bond market in particular, the Treasury market. The problems in Europe where there are very significant imbalances of debt between the various countries and the EMU is causing quite an economic and political commotion in Europe that is resulting in a partial flight out of the so-called peripheral countries into higher-quality countries such as Germany or the U.S. So, the U.S. Treasury bond market has benefited from the problems in Europe.

The problems in Europe also lead to lower growth expectations globally and also that means in the U.S., which further reinforces a downtrend in interest rates, but very importantly as well, the Central Bank, the Fed, has been very aggressive in buying bonds in the open market, and as you know, they have made a commitment to keeping the policy rate essentially fixed for two years, and that has a very important impact on both the level of rates and on the shape of the yield curve.

So, what does that mean for the fund? The fund is currently running a duration of about two years, so that is long relative to its bogie, which is LIBOR, but not substantially long. Our expectation is that the 10-year Treasury rate will be range-bound somewhere between 1.75% and 2.75%.

So, not a substantial prospect for substantially lower rates nor higher rates. So, the two-year duration seems appropriate and enables the fund to capture yield in the portfolio, and we're primarily positioned on the intermediate part of the yield curve where the slope of the yield curve is quite steep and have a pretty significant weighting to mortgage pass-through securities as well.

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