Investing in the Aftershock Economy

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Kimberley Stafford: Rich, big welcome back to you. It's your first secular forum back at PIMCO after spending several years with the Federal Reserve.

Richard Clarida: Well, I'm thrilled to be back and as the saying goes, there's no place like home, so it was great to come back and organize this forum.

Text on screen: Kimberley Stafford, Global Head of Product Strategy

Kimberley Stafford: Oh, that's great. We're delighted that you reassumed your leadership for this process. But you have been here over the years and seen several important secular forums. And so, as you reflect upon past themes, what are the consistent themes that continue to persist today?

Richard Clarida: Yes. Well, I think that's the strength, Kim, of the process. But if you look back, the forum several years ago are still quite relevant.

FULL PAGE GRAPHIC TITLE: Major Developments: A year of shocks. The graphic shows five rows. The first is Hawkish Policy, In response to the sustained surge in global inflation. The second row is Neutral Policy Rates? Debate over the destination for monetary policy rates once (or if) inflation returns to target levels. The third is Bank Failures, Three of the largest failures in U.S. history and the collapse of Credit Suisse in Europe. The fourth row is Industrial Policy, Ambitious U.S. fiscal policies support a newly assertive American industrial policy. The last row is Conflicting Signals, Amid Chinese President Xi Jin Ping’s “third act,” unclear economic and geopolitical direction.

But Kim, what we realized going into this year is that a lot has happened in the past 12 months. We have a very hawkish central bank pivots around the world. We had the biggest bank failures in US history, in the spring, Credit Suisse. And if anything, more escalating tension. And so, where we came down in this forum is with our theme of the aftershock economy.

Text on screen: Richard Clarida, Global Economic Advisor

So we think people navigating the economy and markets need to respect that there will be aftershocks from these disruptions over the next several years.

Kimberley Stafford: So you mentioned we titled the second The Aftershock Economy. So talk about those things that we developed as part of our discussion.

Richard Clarida: Well, we really drew several important macro conclusion.

Text on screen: TITLE – The Aftershock Economy: Key themes, BULLETS - Heightened volatility, less policy support, Global growth will likely disappoint, Inflation expectations should stay anchored at targets, Rates should return to pre-pandemic levels

First, we do think that there's going to be more economic volatility in the next five years. If you look back at the decade before the pandemic, especially in the US data, it wasn't very exciting, but it wasn't very volatile either. We think those days are gone at least for the next five years.

Moreover, the Fed has done a lot of quantitative using, it's bought a lot of assets, about $8 trillion worth in the last decade or so. And so, we highlighted what we may think of as QE fatigue or QE exhaustion, which means less policy support in downturns.

We think global growth is going to slow with risk to the downside. Another key theme, however, is we do think that central banks will do what it takes to keep inflation expectations anchored at their targets. They're going to have a tough job ahead of them, but we think they will succeed in that. And we also think that rates, real policy rates, what we've called the new neutral, a prior secular theme, are also going to return more or less back into the range that we saw before the pandemic.

Kimberley Stafford: So with growth expectations lower, as you mentioned, and our expectations for inflation to return to longer term levels, how are we thinking about the return drivers of fixed income over the secular horizon?

Richard Clarida: Well, I will say that's probably one of the biggest differences from a year ago. We had reaching for resilience, but investors a year ago were reaching for resilience with yields at pretty low levels. Yields are now at the highest starting levels we've seen in 15 years. And so we obviously think investors should seize that opportunity.

Kimberley Stafford: Okay, great. Dan?

Text on screen: Daniel J. Ivascyn, Group Chief Investment Officer

Daniel Ivascyn: Well, we touched on this in the research piece. Not only have we had significant disruption the last few years, it's also important to remember that we were in an incredibly low yield environment for almost a decade or more, coming out of the global financial crisis.

FULL PAGE GRAPHIC TITLE: The Fixed Income Opportunity: Attractive yields and diversification. The bar chart shows yields across fixed income asset classes. The shaded bars show yields as of December 31, 2021 and the solid bars show yields as of May 31, 2023, highlighting higher yields for all eight solid bars – U.S. Core, Global Aggregate, Agency Mortgage Backed Securities, AAA-Securitized, Munis, IG Credit, HY Credit, and EM – as of May 31, 2023.

And again, a good predictor of forward returns and fixed income is the starting yield. We expect a lot more volatility across different cycles, economic cycles. financial cycles, which is going to produce some interesting opportunities from a global opportunity set perspective as well.  So bottom line is that we are excited about a global opportunity set. We're excited about starting valuations, and for more opportunistic capital, we think there's going to be great chances to achieve high returns for the patient investor in some of these sectors that grew a bit too quickly and are going to present attractive opportunities for new capital over the next few years.

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