Professional Documents
Culture Documents
May 2015
AUTHORS
Andrew Balls
Chief Investment Officer,
Revisiting our views
Global Fixed Income
Richard Clarida
is one of the factors
that makes our Secular
Global Strategic Advisor
Daniel Ivascyn
Group Chief
Investment Officer
Forum such an integral
2015 SECULAR FORUM:
part of our investment
process, as it has been
GUEST SPEAKERS
Our distinguished speakers bring fresh
perspectives to challenge our internal expertise.
Nobel laureate economists, policymakers, and
Has the left-tail risk of global deflation been clipped? What is the right-tail risk of the policies
deployed to avoid it?
Chaos in the Middle East and confrontation in Ukraine have been taken in stride by markets
and the global economy, but can this continue? Or are markets too complacent?
May 2015 Secular Outlook 3
The chart shows the implied yield on growth rates, a view now shared by the participate in a global financial system
the December 2018 eurodollar futures International Monetary Fund, which, in that is better capitalized than before the
contract, one proxy for where the its most recent world economic outlook, crisis, and perhaps less vulnerable to a
market expects the Feds policy rate to materially marked down its estimates of systemic run, but understand that it
end up when the next rate hike cycle potential growth in both developed and offers less liquidity to investors and
has concluded. In January 2014 this emerging economies. We also see a appears more susceptible to flash
proxy for the terminal policy rate was global economy that is no longer crashes and vapor locks as the global
about 4%, almost spot on with the old restrained by private sector de-levering balance sheet available for market-mak-
neutral idea that the Fed should but, instead, is learning to live with ing shrinks.
anchor policy at a rate equal to the sum record levels of public and private debt
of the 2% inflation target and the esti- without a cushion that would be pro- For all these reasons, we continue to
mated old neutral real rate of interest, vided by more rapid growth or higher believe that we are now, and will be for
which was thought to be 2%. Since inflation than we foresee. some time, operating in a New Neutral
then, the implied yield on this world in which central banks will be
December 2018 futures contract has While the left-tail threat of deflation in constrained to set policy rates at levels
declined steadily and, at close to 2.5%, Japan and the eurozone has diminished well below those that prevailed before
is right in the middle of the range we due to six-sigma QE programs put in the crisis. In the eurozone and Japan,
estimate for The New Neutral. place by the European Central Bank and where we expect neutral real policy
the Bank of Japan (and in the case of the rates to be negative over most if not all
Whats ahead: A New Neutral ECB an additional negative interest of our secular horizon, we judge both
baseline scenario program in which banks are charged for the ECB and the BOJ leadership to be
In some important respects, our baseline the excess reserve balances on deposit at all in in their attempts to reflate their
views on the secular outlook have not the central bank), we do not in our economies and to be willing to con-
materially changed since the previous baseline foresee an imminent rise in tinue unconventional monetary poli-
PIMCO Secular Forum in May 2014. We prices toward the 2% inflation targets cies for as long as it takes to move as
continue to see a multi-speed world of these central banks aim to achieve. close as possible to their 2% inflation
economies converging to modest trend Regarding financial markets, we targets. What about the Fed? As
The Implied Future Fed Policy Rate Has Declined to a New Neutral Level
December 2018 eurodollar interest rate futures contract implied policy rate
Percent (%)
4.5
Old Neutral = 4%
4.0
3.5
Market has re-priced to New Neutral level
3.0
2.5
2.0
1.5
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May
14 14 14 14 14 14 14 14 14 14 14 14 15 15 15 15 15
INVESTMENT IMPLICATIONS reflation in the eurozone, core European identify should support corporate earn-
country yields are secularly rich but ings and, as with corporate credit, the
Our 2015 Secular Outlook is a continua-
cyclically may be subject to periods secular trends provide a framework for
tion of The New Normal/New Neutral,
of downward pressure including ECB picking winners by region and sector. In
but valuations have changed. A year
QE, sluggish growth and the risk of emerging markets, we will look for
ago, markets were pricing in central
political fragmentation. opportunities to invest in countries with
bank policy rates above the levels
improving growth profiles and economic
implied by our New Neutral framework Corporate credit governance reforms and see the poten-
for the next three to five years. Today, Corporate credit market valuations tial for EM equity outperformance.
markets have fully priced in The New remain well-supported by solid funda-
Neutral and in some cases there may be mentals, and we are generally positive Commodities
insufficient risk premium. The New on the secular credit outlook given the The commodity supercycle is over, as is
Neutral remains an anchor for fixed favorable longer-term trends we identify. the correction due to the supply
income valuations, but we expect to Still, credit market valuations, while response over the last couple of years, in
maintain a cautious stance on devel- broadly fair, are certainly not cheap. We our view. Although commodity prices
oped country duration in our portfo- will continue to look to our credit port- are unlikely to see big swings over the
lios. The six global trends we identify folio management and research special- secular horizon, they will continue to
suggest the baseline of a gradual rise in ists for bottom-up alpha-generating play their role as a portfolio diversifier
yields/re-establishment of term premia security selection, while guided by our and inflation hedge. Another implication
in global fixed income markets. The six overall secular framework. is that headline inflation should more
risks suggest that this will be a slow and, closely track core inflation, affording
most likely, bumpy secular journey. Managing liquidity greater clarity to central banks in their
Making sure that we are paid appropri- inflation targeting.
Inflation-protected securities ately for liquidity and managing liquid-
In the U.S., the major developed country ity in our portfolios will remain Emerging markets
that is the furthest advanced in its important secular considerations across In emerging markets, we will continue
post-crisis normalization, we remain the board and notably in credit markets. to stress country-by-country analysis
concerned that the market is pricing in We are operating in a less risky world in and active management over acronyms.
insufficient risk premium for the terms of leverage in the banking system Compared with developed country fixed
impending Federal Reserve tightening and, at the global level, with a far smaller income markets, emerging markets offer
cycle. The New Neutral framework shadow banking system. However, a attractive secular valuations in a number
provides an anchor but not a ceiling in by-product of increased regulation and of cases, in spite of cyclical headwinds.
terms of our expectations for Fed policy lower leverage is that banks/brokerages
rates. While we expect an elongated are less able to function as market mak- Currencies
economic cycle and growth close to ers. We anticipate ongoing periods of On currencies, in our secular outlook a
potential, the two-sided risks we identify market volatility that investors must be year ago we identified the potential for
on inflation reinforce caution on nomi- prepared for and that, in turn, will offer U.S. dollar appreciation given the U.S.s
nal interest rate duration and also mean opportunities for active managers when leading position among the major
that we continue to favor U.S. TIPS volatility pushes securities prices away developed country economies in The
(Treasury Inflation-Protected Securities) from the underlying fundamentals. New Neutral multi-speed world. Given
as a source of valuable inflation hedging the substantial moves since then, with
at reasonable prices. Equities the U.S. dollar some 15% stronger on a
Our New Neutral rate expectations broad trade-weighted index, expecta-
European bonds support a relatively constructive view on tions for further dollar appreciation
European bond yields have been driven equities. Low discount rates, recovering must be far more modest. But we con-
to very low levels by a combination of but muted inflation and a drawn-out tinue to expect some further gradual
cyclical concerns of deflation risk, business cycle argue for positive equity appreciation of the U.S. dollar, particu-
anticipation of scarcity in the face of performance even at what are cur- larly with the Federal Reserve set to be
ECB QE and concerns over the stability rently full valuations from a historical the first major central bank to embark
of Europes monetary union. Based on perspective. The global trends we on a New Neutral tightening cycle.
our expectations of mild and gradual
May 2015 Secular Outlook 7
15-0445-08-GBL