Cyclical Outlook: Peak Policy, Peak Inflation, Peak Growth

TEXT ON SCREEN: PIMCO

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IMAGE ON SCREEN: Cyclical Forum, Tiffany speaking at the podium in the forum

TEXT ON SCREEN: Tina Adatia, Fixed Income Strategist

Tina Adatia: Tiffany, so we’ve just published our outlook for this forum, inflation inflection. Can you give us an inside look at those key takeaways?

TEXT ON SCREEN: Tiffany Wilding, North American Economist

Tiffany Wilding: Yeah sure. So, I think it can really be summarized very simply, in the sense that we’ve seen the peak pandemic.

TEXT ON SCREEN: TITLE – Economic Outlook: Peak Pandemic, Peak Policy, Peak Growth

IMAGE: Three figures are shown. In the first one, titled “Peak pandemic,” a line graph shows a rising global seven-day average of daily cases per 1 million in population, with the metric at about 50 in June 2021, up from zero in February, and having peaked at more than 100 in April. The second figure is a bar chart, titled “Peak policy support,” showing the DM Economy Fiscal Impulse from January 2002 through January 2024, with the metric forecast to drop to negative 4% by 2022, down from positive 5% two years earlier. The third figure is a line graph titled “Peak growth,” showing the PIMCO DM Real GDP Forecast, from March 2016 to March 2022, with the metric falling to about 3% in March 2020, down from 13% in March 21.

That likely happened in April, when new cases, 7-day new cases started to peak. But with that, we’ve also probably likely seen the peak in policy. So fiscal policy, that we’ve gotten during the pandemic, that is going to start to be dialed back.

 And what we think that this means is that in 2021, you likely see a sort of desynchronized growth recovery between nations. But that leads off into 2022, where you get more of a synchronized growth moderation. And so what does this mean for inflation? Ultimately, inflation lags growth. So as you see growth peaking, and this policy induced demand peaking, inflation will also likely peak as well. I think that there’s more question this time around, the actual timing and the magnitude of that peak inflation as a result of some of these supply-side constraints that have come about, either within the

IMAGE ON SCREEN: Semiconductor manufacturing and shipping containers.

semiconductor industry, or around shipping and logistical bottlenecks, within the United States.

Tina Adatia: Marc, given the 3 peaks in the outlook, can you weigh in on how these to macro conclusions are being applied to portfolios today?

TEXT ON SCREEN: Marc P. Seidner, CIO Non Traditional Strategies

Marc Seidner: There are a few high conviction opportunities at this very, very moment, valuations seem generally rich to us, and our approach is one of patience, focusing on liquidity, and flexibility, and want to be positioned appropriately to capitalize on opportunity as it presents itself over our cyclical horizon.

TEXT ON SCREEN: TITLE – Portfolio implications

IMAGE: Five columns each represent an implication, shown left to right, for the following: rates, securitized, credit, emerging markets, and equities. Two or three features are listed for each implication.

With regard to specifics on investment opportunities or market risks, we expect to stay pretty close to home on overall interest rate or duration positioning.

The steepness of the yield curve and the backup in rates so far this year has created a nice carry and rolldown at intermediate points of yield curves, not just the United States but, globally, to be sure. We favor housing related assets, given the strength of housing in the United States, and quite frankly, around the world, so opportunities in nonagency mortgage backed securities continue.

Agency mortgage backed securities, which were a great opportunity for 2020, have richened to quite overvalued levels, and so we’ve reduced our exposures quite a bit, remain neutral. There’s certainly still opportunity in some of the Covid related or recovery related themes, and we’re seeing opportunity there. We do think that there are unique opportunities in emerging markets, though we’re respectful of the importance of bottom-up research and security selection, because not all countries and not all opportunities are created equal. And then, we’re generally overweight equities, and given fair and a relatively rich world, it seems okay to be still slightly overweight equities, given our macro views.

Tina Adatia: Moving on from this, Marc, can you talk about the role of fixed income at this point in the cycle?

TEXT ON SCREEN: TITLE – The role of fixed income

IMAGE: A box lists three bulleted items: yield, carry and diversification.

Marc Seidner: The role of fixed income historically is, a positive term premia, which gives you an expected higher yield or return than sitting in cash.

There is some carry, and importantly, there is the benefit of diversification, in an uncertain outlook. And while those three characteristics didn’t necessarily hold a year ago, as we think about the cyclical horizon, those three characteristics are once again in place.

Tina Adatia: Many investors are worried about rising rates. Tiffany, what is PIMCO’s view on rising rates?

TEXT ON SCREEN: TITLE – Past peak monetary policy, but central banks likely to stay the course; SUBTITLE – Past peak monetary policy, as central banks look to slow asset purchases

IMAGE: A line graph shows cumulative net purchases for seven central banks, from January 2020 through May 2021. All seven start around zero, and rise to levels between 10% and 18% over the time period. The Reserve Bank of Australia cumulative purchases are at 10% by May 2021, the lowest, and that of Reserve Bank of New Zealand is at 18% by April 2021, the highest. The Federal Reserve’s is about 13% in May 2021.

Tiffany Wilding: So, Monetary policy, that impulse, if you will, is likely peaking. But, looking a little bit further out, just because this policy impulse as we call it, has peaked, doesn’t mean that we think that central banks are actually going to be quick to start to remove policy or raise interest rates.

So, the Federal Reserve, for example, we don’t think they raise interest rates until well into 2023 and of course, other central banks could be even later than that. So the ECB, of course, could be one that’s later. So I think that’s the thing could keep in mind here, is although there is a policy peak that’s happening, we think central banks will largely kind of stay the course on interest rates.

Tina Adatia: Marc, in the case that rates do rise, which fixed income sectors can be expected to outperform?

Marc Seidner: Well, let’s start off with a couple points. One, let’s be clear, rising rates aren’t always bad. Yes, they can negatively impact near-term performance, but rising rates

IMAGE ON SCREEN: PIMCO trade floor

can lead to higher levels of longer-term performance, and longer prospective returns, particularly in the context of what Tiffany mentioned, with central banks likely anchoring short-term interest rates at extraordinarily accommodative and extraordinarily low levels, beyond our cyclical horizon.

So, rising rates aren’t necessarily bad.

TEXT ON SCREEN: Higher rates may mitigate against downside risk

IMAGE ON SCREEN: PIMCO trade floor

Higher rates, as I mentioned earlier, may potentially provide protection against downside risk in a broader asset allocation.

And as we look around the world, there are opportunities where interest rates is have already risen, and create some opportunities. So we encourage investors to think about bonds from a global context, not just one particular country or opportunity.

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