The investment strategy of fixed-income specialist Pimco has changed over the past four weeks from being weighted towards US Treasuries to emphasising spread products.

In an interview with AsianInvestor, Bill Gross, managing director and CIO in Newport Beach, California, says, "US Treasuries are totally overvalued," noting the current 375 basis point yield for 10-year US Treasury bonds is unlikely to last in the face of rising inflation.

The June edition of AsianInvestor magazine will provide an in-depth analysis of how US portfolio managers are positioning themselves as the financial system nears the end of the credit crunch, and the implications for returns on investment for global investors.

Pimco was among a handful of bond investment firms that overweighted Treasuries in the run up to the US housing-inspired credit crisis that begun last summer. Since then a flight to quality has driven many investors to Treasuries while the US Federal Reserve has sharply eased monetary policy û moves that Pimco predicted early.

Now Gross thinks that recent undertakings by the Fed and the US Treasury Department to support the housing market will bear fruit, and while this doesn't suggest the US homeowner (and consumer) can expect a return to pre-2007 conditions, he expects the economy will barely avoid a recession.

That should give the Fed room to eventually raise interest rates, which it needs to do as inflation becomes a bigger threat. The current 2% level for the federal funds rate is negative in real terms, and although the Fed could cut it further, the consequences for the dollar and for inflation could be severe.

That would be good news for policymakers in Asian countries including China, which have effectively adopted this loose monetary policy through fixed or managed exchange rates. Low US interest rates are therefore feeding inflation in Asian and other emerging-market economies, at a time when many Asian countries also suffer from rising prices in commodities as well as marginal increases in labour prices.

The Fed's ability to raise interest rates depends on the US housing market, says Gross. If a number of policies and legislative measures to boost liquidity in the financial system, ease access to credit and avoid mass foreclosures on home ownership are implemented, then housing prices should stabilise, and Pimco's new bets on spread products will pay off.

If not, however, then the Fed could be forced to keep short-term rates at 2% well into 2009, which threatens to undermine the dollar and will accelerate global investors' desire to find alternative channels of investment.

But Pimco has decided it looks like housing prices will stabilise and mass foreclosures will be prevented, and has therefore begun to move away from expensive Treasuries into high-quality credit institutions, particularly financials that should survive the crisis.

The Fed's act as midwife to the liquidation of Bear Stearns, the United Kingdom's nationalisation of Northern Rock and other policy decisions (including providing investment banks with access to the Fed's discount window) have expanded the net of government protection beyond commercial banks. Pimco considers financial institutions such as AIG, Wells Fargo and Bear Stearns-cum-JPMorgan as 'money good' and their ongoing issuance of bonds to recapitalise now offer yields far more attractive than US Treasuries.