Risk of U.S. deflation is rising: Pimco

The United States faces a rising risk of deflation that could bolster prices of safe-haven U.S. government bonds, while hurting the prices of real estate and stocks, the world's biggest bond fund management company said on Tuesday.

The prices of five-year through 10-year Treasuries could initially rise, Pacific Investment Management Co said.

Against the backdrop of a deflation risk, "it is likely the Federal Reserve will have no choice but to keep rates on hold for a very long period," Scott Mather, head of global portfolio management with Pimco, wrote in an article on the company's website.

The Federal Reserve will deliver its interest rate decision and policy statement at about 2:15 p.m on Tuesday.

A deflation scenario "would have profound implications for asset prices," Mather wrote.

"The risk is rising that the U.S. will enter a prolonged period of stagnant growth combined with a risk of outright deflation -- similar to the environment that Japan entered in the 1990s," Mather wrote. "The last 20 years in Japan have seen continuously deflating real estate and equity prices."

"Outright deflation" would occur if large swathes of the economy experienced negative price pressures over a long period of time, which then fed into expectations that prices would continue to fall broadly, Mather said.

Mild deflation, by contrast, would occur if prices fell briefly in some sectors of the economy, but consumers did not begin to expect broad, sustained price declines, he said.

Pimco has over $1 trillion of assets under management.

"It is likely that the poor employment picture will pin the (Fed's) policy rate for a long time," Mohamed El-Erian, co-chief investment officer at Pimco, told Reuters in an interview on Friday.

"Moreover, it is likely that some in Washington will want the Fed to do more, such as restarting the asset purchase program," El-Erian said.

The Fed may ultimately buy Treasuries again, Mather wrote.

Such purchases would aim to keep borrowing costs low in an effort to stimulate economic growth.

On Thursday, El-Erian told reporters that the risks of the U.S. economy entering a double-dip recession and falling into deflation may be around one in four.

[Source: By John Parry and Jennifer Ablan, Reuters, New York, 10Aug10]

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