Economic and Market Commentary

History Rhymes: Preparing for an Imminent Recession

05/04/2023

Tiffany Wilding

Studying over 70 years of data lead us to believe that a recession may be imminent. Watch PIMCO Economist Tiffany Wilding discuss the economic implications of rising interest rates, and why investors may do well to stay invested in bonds.

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Text on screen: Tiffany Wilding, Economist

Wilding: So last October, we published our cyclical outlook prevailing under pressure. And in that note we made several observations. And the first was obviously that inflation was elevated, but the central bank policy response to that elevated inflation was one of the swiftest responses that we've seen in modern times, and that would likely produce a recession in order to bring down inflation.

The basis of our analysis that recessions were likely in the United States in 2023, it was a historical analysis that we did across various developed markets over the last 70 years where we looked at hiking cycles and specifically the start of a hiking cycle and what and what ensued in an economy after that. We found that around 2 to 2 and a half years on average, after the start of a hiking cycle, you tended to see recessions across developed markets and you tended to see output gaps decelerate before that.

Interestingly, as a result of that, we suggested that a recession was highly likely in 2023. And as it's playing out, we do appear to be getting closer to that. You know, more recently we've seen banking sector stress with the failure of Silicon Valley bank as well, signature bank, and then obviously the escalation of stress in European markets with the ultimate deal for UBS to buy Credit Suisse.

So although we didn't necessarily forecast these specific, idiosyncratic developments, the historical analysis that we did is actually not wildly off in terms of the timing for when these stresses would be expected. So interestingly, although history doesn't always repeat, you know, sometimes it does rhyme.

So what does that mean for investors? Well, our investment implications in our cyclical outlook have been we think bonds are back. We think the higher starting yields, plus the likelihood that the diversification benefits of bonds will come back this year as the economy moves into recession, makes them a valuable portion of any investor's portfolio.

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All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Diversification does not ensure against loss.

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