Yield Advantage: Key Takeaways from PIMCO's Secular Outlook
Text on screen: PIMCO
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Text on screen: Anna Dragesic, HEAD OF GLOBAL CREDIT PRODUCT STRATEGIES
Dragesic: Rich, our secular forums are at the heart of PIMCO's investment process and has been for multiple decades. It provides a useful compass for navigating the global markets over the next five years, and having this long-term view is important because it's a complement to our cyclical outlook that focuses on the next six to 12 months.
Dragesic: Can you provide some of the key insights and themes that came out of our conversation?
Clarida: Well, an important bottom line is we went through a decade of reaching for yield, and now there's a yield to be seized and a yield advantage. So that's an important point.
And importantly , central banks have achieved disinflation. Inflation is running at two point something, which is part of our thesis a year ago. It really creates a compelling outlook for fixed income with this generational reset in yields and inflation close to central bank targets. We're in a world of elevated macro and geopolitical risk. That's not going away. But some of the macro risks we saw last year, we think is migrated into market valuation in certain sectors of the markets, and in particular, also ongoing super secular trends in which credit's been moving away from bank intermediation towards financial markets.
Dragesic: Great. So you mentioned some risks, but we also talked about some disruptors. So Rich, I want to ask you what are possible disruptors to thesis, what are we watching out for over the next few years?
Clarida: Anna, I'm glad you asked that, because a lot of times folks really focus on a baseline view and we have a baseline view. But part of what we get paid to do in active management is to look at potential surprises and disruptions.
An important thing that I think we've all seen that's been played out is any worries that we might have had about fiscal policy a year ago. We have even more evidence, fiscal policy in the US and abroad is on an unsustainable path. That's going to limit policy space. That could be a potential disruptor, a dangerous geopolitical situation, a hot war in Europe now in the Middle East. Moving to a multipolar world.
AI, we had a dedicated session on AI at the secular. We're convinced that it is a big deal, but it is also something which may take longer to show up in the macro data than it does in some other data and in particular valuations, particular sectors. And then finally, it's 2024, elections. More than, nearly two thirds of the world's population is voting in elections this year. We've already had some election surprises. We've got some elections coming up in many countries. And that obviously can potentially be a disrupter as well.
Dragesic: Okay. I want to still stay on this theme of just these higher debt levels. And given these high debt levels, what do you think this means for the term premium and the potential steepness of the yield curve over the next few years?
Clarida: Yeah. So one thing that we're very convinced on at PIMCO is that an inverted yield curve is not the new normal. The US yield curve is going to re-steepen, and it's our view that most of that re-steepening will happen as the front end comes down. And that a term premium, which is the reward investors earn for taking on duration risk, will return.
Real yields, if you look at inflation index bonds, are at levels that we haven't seen in 15 years. So just as we've had a reset in nominal yields, also in real yields, and together that likelihood of a steeper curve and those yields means there's a cushion right now in fixed income markets that we haven't seen in a long time.
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