What to Expect When You’re Expecting Rate Cuts
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Text on screen: Kimberley Stafford, Global Head of Product Strategy
Kim Stafford: Hello, I'm Kim Stafford and I'm here again with PIMCO Group CIO Dan Ivascyn to give you an inside look at some of the recent discussions taking place within PIMCO's Investment Committee or IC. Thank you for joining us, Dan.
Dan Ivascyn: Thanks Kim.
Kim Stafford: There's been tremendous focus on central bank activity, including how long the Fed may take to cut rates if U.S. inflation remains sticky. We just published our cyclical outlook, and one of the main themes was around increasing divergence among economies, both in terms of monetary policy and growth. So how is this divergence playing out and what are the investment opportunities?
Dan Ivascyn: Sure. Let's start with growth. The U.S. economy in particular is exhibiting a lot of growth resiliency, a lot of economic momentum. And apparently the U.S. economy is less sensitive to the interest rate increases we've seen so far. Outside the United States, much different picture. You are seeing some signs of more material weakening across economies in Europe, in the U.K. as an example.
What we think that will do is allow
Images on screen: Global central banks
central banks to ease policy outside the U.S., perhaps off cycle, not necessarily in a more synchronized fashion with the central bank here in this country. And of course, that provides attractive opportunities. In addition, economic fundamentals, now, when you look at
Text on screen: Global yields are attractive today
Images on screen: Global stock markets
global yields, they're quite attractive and they hadn't been attractive for a long period of time. And they're looking good currently.
In terms of central bank policy, we do think finally after the repricing we've seen year to date, that the forward curves or what's embedded in terms of market expectations are pretty close to what the
Images on screen: The U.S. Federal Reserve
Fed will likely do and we do think that the Fed probably cuts rates later this year, perhaps they cut rates a couple of times this year in terms of our base case thinking.
But with economic growth strong, with inflation stubbornly high, there are risks that the central bank doesn't go at all. There's even ten, 20% chance type risks that they have to tighten the cycle as well. So a lot of uncertainty.
Text on screen: Volatility creates opportunities for active fixed income to outperform
Images on screen: PIMCO trade floor
But what's been great for active fixed income is that this volatility of these less synchronized cycles are providing great opportunities to diversify portfolios and to target these markets for alpha generating opportunities.
Kim Stafford: You mentioned bond yields rising in recent weeks given elevated inflation and the market's pulling back their expectations for rate cuts maybe later this year. What are the implications for rising yields and how is that an investment opportunity for clients?
Dan Ivascyn: Sure, from a longer-term perspective, yields look very, very attractive. Nominal yields, now back up in the 5% area, in the intermediate portion of the curve or even if you want to protect against inflation and you look at real yields, real yields comfortably above 2%, look very attractive from a historical perspective.
When you step back and look at fixed income valuations from a longer-term perspective, 7-8% high quality bond yields look very attractive versus public equities. In fact, you're getting a public equity type return with a much better bounded overall profile and 7 to 8% type yields in a high-quality bond portfolio have historically looked very attractive versus cash.
So this is a time where we don't think you can guarantee that cash rates are going to be at five or five and a half percent much longer. I think that's typically the time we're extending out the curve, locking in these very attractive yields.
Over the short term now our thinking is that after the sell off we've witnessed more recently it's time to get back to a neutral or even a slight overweight position to interest rate risk across most portfolios we manage. And we're doing that not only in the United States market, but doing it through diversified purchases of other higher quality government bonds in areas like
Images on screen: Australia, Canada, the United Kingdom
Australia, Canada, even the U.K. as an example. So we do think from a tactical perspective now after the recent sell off, perhaps it's a bit overdone and we think the prospects for more stable yields around these levels or even a drop in yields later this year are looking better and better, so attractive income with attractive total return potential as well.
Kim Stafford: Great. You talked about elevated yields can be a boon for investors, as you just described, but they can also pose risks for borrowers. What are the investment implications for higher for longer rates for borrowers and credit markets? And where is this also creating opportunities for investors?
Dan Ivascyn: Higher base rates are creating challenges in certain areas of the economy. We see the direct impact on regional banks that have some challenges with the commercial real estate area. We're also beginning to see further signs of deterioration in areas like
Images on screen: Commercial real estate building exteriors
Commercial real estate and some of the private credit sectors as well.
What those sectors have in common is that a lot of the funding is done in the floating rate markets and with these higher short-term rates that are going to stay higher for longer
You'll continue to see some duration. That, of course, presents opportunity for new sources of capital. So we do think that you'll see some more challenges, perhaps even at an accelerating rate as we get into the end of this year and into early 25, especially if you see some economic weakening.
Kim Stafford: And you described potential new sources of capital, what are the opportunities that you're seeing there?
Dan Ivascyn: Yeah, there are opportunities across the spectrum. In the public markets now, you've seen with increased volatility within the equity markets, some of the geopolitical risks, some spread widening and some interesting
Text on screen: TITLE – Areas of opportunity today:, BULLETS – Corporate credit, Real estate credit (Multifamily), Asset-based credit (Consumer-related)
opportunities cropping up with just the traditional corporate credit markets are also an increased pace of selling from regional banks, from other holders of risk across the commercial real estate spectrum, riskier segments like office, but also see, you know, more interesting opportunities even in the multifamily space as well then asset backed exposure in general.
We're very overweight that exposure across PIMCO funds. We still think seasoned lending to consumers is the most resilient and attractive area of the credit universe. And these opportunities could be targeted both within traditional mutual funds as well as more aggressive, higher returning vehicles as well.
Kim Stafford: Well, thank you very much, Dan. And thanks to all of you for joining us. We'll see you next time.
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