PIMCO’s Outlook for Global Bonds Amid Tariffs & Rate Cuts

Text on screen: David Orazio, Head of Distribution, Global Wealth Management

Orazio: Given the recent market volatility, we thought it would be an opportune time to talk to Sachin Gupta, lead portfolio manager of the PIMCO Global Bond Fund, of how he's navigating the market environment and positioning client portfolios.

Sachin, Liberation Day was a catalyst for a large amount of market volatility. How is PIMCO's market outlook evolved since this day?

Text on screen: Sachin Gupta, Portfolio Manager and Head of the Global Desk

Gupta: Hey David, you're right about the volatility. The tariff announcements on the 2nd of April, I think, caught, almost everybody in the markets by surprise, which is very clear when you look at the reaction of the markets, the side effects where there was bonds or equities or currencies, there was a significant increase in volatility across the board.

Now, what did it all mean for macro or for growth inflation? Well number one, larger tariffs. To the extent that they act like a tax on consumption in the US, effectively forced market participants to revise the growth forecasts down, for us it meant, you know, growth pretty close to zero in our base case. And, you know, probability of recession, you know, perhaps as high as about 50% or so.

On the other hand, again, the same tariffs, even as they're acting as a tax on the consumption, we believe would also lead to higher inflation. And our economist team, saw the risk of, core inflation peaking, you know, perhaps as high as 4-4.5% this year. Both of those, growth and inflation estimates, were meaningfully, you know, worse, than what we thought the day before the announcements, for example.

Now, having said that, let me also remind ourselves, the tariffs were subsequently paused. And the U.S. is now engaged, in trade negotiations with well over 100 countries, including almost all the important trading partners, out there. So, you know, let's see what the destination is, where we end up as some of these deals start to get agreed or, or announced. So the final destination on tariffs may end up being meaningfully different than what was announced on the 2nd of April.

And, you know, and subsequently, and if that were to happen, it will naturally affect how we and others in the market think about growth and inflation risks.

Orazio: Sachin, with this market volatility we've seen a lot of price action across yield curves. At the front end many yield curves have rallied. But at the back end of the yield curve, particularly in the US we've seen that sell off.

Now do you give any credence to the rumours that foreign buyers, particularly of U.S. assets and U.S. treasuries, are selling these assets, therefore putting pressure on U.S. long term yields?

Gupta: Yeah, this is something that, has been garnering a lot of market attention, David. For exactly the sort of reason that you just highlighted. Well first and foremost, if the risks to growth start to materialise on the downside, we know through our understanding and pretty good understanding of Fed's reaction function, that over time, policy rates are going to go down.

And when that happens, yield curve naturally steepens. In other words, the front end of the yield curve, the twos, the threes, the fives, they rally more, pricing in the rate cuts, while the long end does not rally as much, because over a longer horizon rates go down, but they go back up again, right? And so the natural state of affairs for yield curve in times of stress when growth is slowing down is to steepen. And that's what we've seen this time around. And U.S. is not alone in that.

You know, you've seen that across all the major bond markets, including Australia for that matter. And the question really is, have you seen, activity in terms of, investor behaviour in U.S. that is a bit different or on top of what you would have expected, like I just described.  Now, it is still too soon, it's only been about two and a half, three weeks. You know, since the start of the recent volatility, the data that we have seen so far, does not suggest that foreigners have been net sellers in any sort of big size. In fact, combined, foreigners have actually increased their holding of treasuries and U.S. fixed income assets over the short time period.

Now, as the time passes and we get more detailed information on precise data, we may have a bit more colour at this point in time. It's a bit more consolidated and aggregate information, but it's not clear from the data that that might have happened.

Orazio: Let's turn to asset allocation. How does fixed income look relative to equities and also cash or the front end of the yield curve?

Gupta: Yeah I mean this is where the rubber meets the road right David. So I think as you know, I mean our colleagues have been sort of, talking about this for a little while, even well before this, recent upheaval, bonds, when you look at valuations, you know, whether versus equities or just cash or front end, you know, bond markets have been looking particularly the high quality bonds in developed market space have been looking pretty attractive.

Part of it is simply because bond yields rose over the previous two years from pretty low levels post Covid, to now levels in most countries which existed only in the pre global financial crisis years. Right? So we think on an absolute basis, bond yields look pretty attractive. And then on top of it, you know, when you look at bond yields and compared to equities on, on various different metrics, bonds look also very attractive relative to equities on a variety of those metrics.

And then thirdly, when you think about cash or front end, which is where a lot of, our clients or investors, you know, may have parked their money temporarily, bond yields also look attractive because, as you look forward and it's already been happening in the last few quarters. But we know that the cycles are slowing. We know that inflation certainly most of the world is headed lower. U.S., a little bit of question mark because of the tariff situation. And as that happens, various central banks have already been cutting rates and delivering monetary policy easing. Now, there is a lot more to go on that front. So as the cycle continues, down that path, the cash yields are going to continue to fall. And essentially, clients who are invested in cash will find themselves taking a lot of reinvestment risk. Right?

So by the time you roll your deposits or other things, the yields might be a lot lower, than when you initially went in. And that's where, you know, having a bond portfolio brings advantages because you benefit from the decline in bond yields, because the prices go up in your portfolio. So I think that's I would say. The bonds actually look attractive, both compared to equities as well as cash because of starting yields as well as where we are, in this monetary policy cycle with a bunch of rate cuts yet to come.

Orazio: Sachin, how are you positioning the PIMCO Global Bond Fund? Are there any opportunities that you're looking at to take advantage of, in light of the recent volatility?

Gupta: Absolutely. You know, first and foremost, we are running duration, higher than that in the benchmark. In other words, we are long duration in the portfolios.

We are positioning the portfolio to benefit from declining yields. On the heels of, many more rate cuts to come across a multitude of bond markets, that’s sort of number one.

Number two, while there is a lot of uncertainty around related to tariffs, what we sort of are quite sure of or have a good amount of conviction on is the opportunities, particularly in the global landscape. So there are a few economies where we think the rates should be by the time the cycle finishes, the rate should be, you know, meaningfully lower than where the markets have been pricing them. Australia and UK are two of our top choices in terms of taking that duration risk, markets are still pricing an end to the cycle in 3 - 3.5% range. While we think that by the time, you know, the cycle finishes and inflation has bottomed out, rates in both of these countries, should be meaningfully lower.

Now, that's before factoring in any of the risks coming from the escalation of trade tensions and tariffs coming from U.S. administration, those things only work to further increase the downside risk on growth and potentially also increase the downside risk on inflation.

To the extent that some of the goods which were destined for American consumers may have to find their way to other consumers in these economies. Because the tariffs make it too expensive to, to sell into America, for example. Right. So both growth and inflation risks are skewed to the downside, which make duration in the rest of the world in global bond markets even more attractive.

Secondly, as we’re taking that duration risk, we are very much focused on what we call as belly of the curve or, somewhere in the 5-10 year region. And that's essentially to benefit from curve steepening or the front end of the yield curve benefiting more from rate cuts compared to the long end.

This decision has already been, by the way, very beneficial for the fund. But we think that, in the context of where we are in the cycle that is a good bit, yet to come. So that's sort of, on the duration side of things.

Now, looking at non-government type of assets, there are plenty of good opportunities. You know, particularly, for example, Triple-A rated agency mortgages or some of the other securitised assets here in the U.S. or even in continental Europe after the recent volatility, they've actually started to look quite attractive again.

So, I think that's a great place to earn not only extra yield, but also a good deal of price appreciation as, a combination of both as things normalise, but also over time, bond yields head lower. All of these assets are poised to do quite well. Right. So there's several opportunities like that that we that we quite like.

In the spread space, there are several good opportunities. Senior financials, the yields and spreads have backed up a little bit, particularly large six names in U.S. or national champions in Europe. And so we're focused on having, allocation to those in the portfolio. Similarly, there are opportunities in high quality emerging market countries in the Middle East, and in Eastern Europe, we quite like, a whole host of names there. And we have some allocation to those as well. So, there are a tonne of opportunity in the global landscape, which we are very much focused on, and adding risk to the portfolio to sort of position the Bond Fund, to benefit from all this upheaval, certainly over the cyclical horizon.

Orazio: What are some of the areas and developments that you, your fellow portfolio managers and the IC are monitoring going forward?

Gupta: Yeah, this is a great question actually. So, I think the single most important,

area to monitor is the tariffs themselves. Right. We are in this 90 day pause, like we were discussing earlier. Several countries are negotiating with the U.S., but we want to see these deals come through, or at the very least, a very clear understanding of what the shape of these deals will look like. And so I think any of the major, trading partners, agreeing an outline of a deal with U.S. would be very important for the bond markets, for markets at large. And something that might actually be a sign of things to come.

Within that, administration is starting to engage with China would be extremely important. Remember, China is one of the largest trading partners of the U.S. And also at this point in time, the tariffs are pretty high at 145%. And, of course, it's sort of unsustainable.

So, any signs, of engagement and, potentially, the two sides working towards some sort of a deal would be, would be a very, very important development. So, I think the trade and those things are both of those are significantly important.

The other couple of things that I would mention is, number one, let's not forget, Congress has been working on a budget for the last few weeks. And so, as we go into the summer, we should start to see the contours of that budget deal in U.S. come through. And that'll be an area of keen interest. It matters, I mean, the total really, you know, matters, but what also matters is the composition. And that'll tell us what to expect from the DOGE) spending cuts. But also, if the Congress is going to be able to deliver any of the further tax cuts that President Trump promised in his campaign.

And then lastly, it's important to keep an eye out on the rest of the world as well, even though countries are engaged in trade negotiations with U.S., there is a good chance that some of these countries end up in a place where they may need to open up the fiscal policy, a bit more to shield or, help their economies, through the negative impact of, both trade uncertainty, but also potentially whatever is the new trade agreement or trade relationship with the U.S. And so that additional fiscal spending, will certainly have some impact on their own bond markets and, of course, present opportunities, I guess, for both, bond as well as equity investors focused on those markets.

Orazio: What's our view on the U.S. dollar? Is there a risk that the U.S. loses its status as a reserve currency of the world?

Gupta: You know, I think based on what we have seen so far David, I would say the risk is pretty small. Fundamentally, U.S. is in a very unique place, given the size of its bond markets, the liquidity of assets, both in bonds as well as equities and otherwise, which is very unique relative to the rest of the world.

So it's not like there are alternatives for global reserve managers, to be able to put that much money in something which is very liquid, it's a store of value and allows them to achieve the various policy objectives that they need from those reserves. Remember, close to about 80% of global trade is still invoiced in dollars. So there is a genuine need for a variety of countries to hold foreign exchange reserves and, a large portion of that in dollars.

Having said that, we do expect some weakness in the dollar and that's a little bit different than, any risk to reserve currency status. That's more, number one coming  from the possibility, that tariffs will end up affecting U.S. growth.

Like I discussed earlier, there is some downside risk to that. The distribution is wide because we don't know what the final destination on tariffs is, but it's clear that there are downside risks. And if those risks materialise, we'll likely see some weakness in the dollar from a cyclical standpoint.

Additionally the last point I will make is the reality is, the rest of the world owns a lot of dollar assets and particularly the private sector, are investors, whether they are wealth management investors, pension funds and a variety of other entities. They own, most of their holdings of U.S. assets are actually U.S. equities. And we know that U.S. equity investors tend to hold them in a unhedged manner or in dollars instead of hedging them in their own currency.

So there is a distinct possibility because there is a very large amount of these holdings out there that some of these investors decide to perhaps increase their hedge ratios a little bit just in response to recent volatility. And because the stock of assets is so large, that might lead to additional sort of headwind for the dollar in terms of those hedges, starting to increase a bit. So, I don't think there is a reserve currency status issue at this juncture. There is certainly risk from a cyclical standpoint to U.S. growth and hence the dollar, and then there is also a possibility that hedge ratios and the stock of U.S. assets held outside the U.S., inch up a little bit. And so those things, certainly can create weakness in the dollar.

Orazio: Thanks Sachin. Given what's going on in markets, it's been a really interesting discussion today, and I'm sure our clients will find this super helpful in understanding our latest views, but more importantly, how you're positioning portfolios to take advantage of opportunities that this market volatility provides.

As always, if you've got any questions or would like further information of anything that we've covered today, please reach out to your PIMCO Account Manager.