By Wes Goodman Jan. 4 (Bloomberg) -- Pacific Investment Management Co., which runs the world’s biggest bond fund, is cutting holdings of U.S. and U.K. debt as the two nations increase borrowing to record levels. Pimco is “more cautious” on corporate bonds and holds fewer mortgage-backed securities than the percentages in the benchmarks it uses to gauge performance, wrote Paul McCulley, a portfolio manager and member of the investment committee, in his 2010 outlook. The company is also underweight Treasury Inflation Protected Securities, according to the report on Newport Beach, California-based Pimco’s Web site. “This all leaves us with portfolios that appear, more than at other times, to be hugging the benchmarks with no bold positioning,” McCulley wrote. “We’re making a very active decision to run light on risk.” Yields, which move opposite to prices, will rise in the U.S. and the U.K. this year, according to Bloomberg surveys of economists. Treasuries fell 3.7 percent in 2009, the most in more than three decades, according to indexes compiled by Bank of America’s Merrill Lynch unit, as the U.S. increased debt sales to snap the biggest economic slump since the 1930s. U.K. gilts fell 1.3 percent last year, the indexes show. The yield on the benchmark 10-year note rose four basis points to 3.87 percent as of 12:22 p.m. in Tokyo, according to BGCantor Market Data. The 3.375 percent security dropped 9/32, or $2.81 per $1,000 face amount, to 95 31/32. Yields advanced to 3.91 percent on Dec. 31, the highest level in six months. Yield Outlook Yields will climb to 3.97 percent by year-end, according to a Bloomberg survey with the most recent forecasts given the heaviest weightings. U.K. 10-year rates will advance to 4.31 percent from today’s 4.01 percent, a separate survey showed. Bill Gross, who manages the record $199.5 billion Pimco Total Return Fund, cut government debt holdings and boosted cash to the most since Lehman Brothers Holdings Inc. collapsed in 2008, the company reported on its Web site on Dec. 18. The fund returned 13.8 percent last year, beating about half of its competitors, according to data compiled by Bloomberg. Under what Pimco has termed the “new normal,” investors will face lower-than-average returns with heightened government regulation, lower consumption, slower growth and a shrinking global role for the U.S. economy. Tight Credit Federal Reserve Vice Chairman Donald Kohn said tight bank credit and caution among households and businesses may impede spending amid an improvement in financial markets, speaking yesterday to the American Economic Association in Atlanta. The Fed may amend its promise to hold interest rates at a record for an “extended period,” though it will refrain from raising borrowing costs in 2010, according to Pimco, which is a unit of Munich-based insurer Allianz SE. “The moment the Fed changes any one of its words, it’s going to be a very unpleasant experience,” McCulley wrote. Treasuries tumbled in 2009 as U.S. marketable debt increased to a record $7.17 trillion in November from $5.8 trillion at the end of 2008. Fed officials are considering a proposal to schedule limited sales of bonds as part of a range of tools for withdrawing record monetary stimulus. The U.S. central bank has purchased mortgage-backed securities, Treasuries and federal housing agency debt, expanding its balance sheet by more than $1 trillion during the crisis. Asset Sales The Federal Open Market Committee discussed asset sales at its November meeting, with some members in favor and others warning it would cause “sharp increases” in longer-term interest rates, according to minutes of the meeting released on Nov. 24. U.K. bond sales will surge to a record 220 billion pounds ($354.4 billion) in the fiscal year ending March 31, a 50 percent jump from the previous year and a fourfold increase from the average in the five years before Lehman Brothers collapsed in 2008. Pimco is turning less optimistic on corporate bonds and mortgage-backed securities following their gains in 2009, McCulley said. The company’s money managers favor sovereign debt, corporate bonds and currencies in emerging markets, he wrote. Extra Holdings Pimco added to its holdings of securities sold by governments and companies in the Middle East after Dubai World on Nov. 25 asked to delay payments on some of its debt, triggering a slump in some emerging-market assets, Michael Gomez, co-head of emerging markets at the money manager said Dec. 10. Pimco holds fewer Treasury Inflation Protected Securities than the amounts in its benchmarks, McCulley wrote. “Risks are currently weighted toward a disinflationary environment,” the report said. Disinflation is a slowing of inflation. Pimco is “modestly bullish” on bonds from the countries that share the euro, according to the report. The company is positive on Build America Bonds and is “fairly neutral on plain old municipal bonds,” the report said. To contact the reporter on this story: Wes Goodman in Singapore at wgoodman@bloomberg.net.

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