Deficit Dynamics: Navigating the U.S. Fiscal Landscape

Text on screen: PIMCO

Text on screen: PIMCO provides services only to qualified institutions and investors. This is not an offer to any person in any jurisdiction where unlawful or unauthorized.

Text on screen: Kimberley Stafford, GLOBAL HEAD OF PRODUCT STRATEGY

Stafford: How do you think about a rising debt trajectory and its potential impact on bonds? Who's buying treasuries, and how can an active manager both position and protect around some of these broader themes that we're talking about?

Text on screen: Daniel J. Ivascyn, GROUP CHIEF INVESTMENT OFFICER

Ivascyn: Sure. So we'll start with deficits. We do think the United States is in a unique position relative to other developed market countries in that we still have the global reserve currency.

We still have this flight to quality dynamic to the United States, and a confidence in US institutions that allows us to be more irresponsible on the fiscal side than others.

But with that said, these deficits are notable. They're higher than most other developed countries, and there's going to be practical limitations in terms of impact. It's likely that our interest rates are inflation adjusted, or real rates are higher than they would be otherwise because of deficits. We expect yield curves to be steeper than they would be otherwise, and volatility will likely be higher as well. And over time, there are other areas of the world that will look more attractive in a relative sense.

Images on screen: The U.S. Treasury building, USD currency printing

So although we've spent a lot of time analyzing these debt levels or deficits in historical contexts and are of the view that we have a bit more time here in this country, it's a risk and it's a concern.

I think it's important to note that what may make sense over the longer term, in terms of setting up the conditions for higher sustainable growth, can be somewhat in conflict to the current environment, where we have an economy that's still operating with inflation above central bank targets. Where there's a tremendous amount of economic momentum, where labor markets are still relatively tight. This is going to be the tension. And the question, of course, will be and we're focused very much on how the Trump administration is going to deal with this tension between longer term goals and potential short-term concerns.

If, and we saw a flavor of this in the initial reaction to the Trump win, if some of these policies lead to near-term inflationary pressure, the markets are going to tighten financial conditions on their own. And that very well could mean not only higher interest rates, but at some point, some pressure on risk assets as well, to the extent that yields are going higher because of concerns around inflation, the Fed has said

Images on screen: The Federal Reserve Building

very, very clearly that they are going to react and respond if inflation does not get back to target or if it reaccelerates. And they're very, very focused on inflationary expectations. So it's going to be this tension that the administration is going to need to navigate. And we and the rest of the market are very, very focused in those areas.

We do think deficits are going to remain elevated. And they're already high in a strong economy, which means if the economy were to weaken, they would likely go even higher. So what are we doing about that across portfolios? We see attractive value in the bond market. But the US isn't the only game in town.

Text on screen: Key investor takeaways: 1. Global diversification

Images on screen: Australia and The United Kingdom city skylines

We've also been talking about a theme of diversifying our exposure across the globe. Other parts of the world, Australia, the United Kingdom, our high-quality markets, a better fiscal situation, arguably a less dynamic economy, and a little bit of economic weakness is really good for fixed income performance, all else equal, and even some higher quality areas of the emerging markets that have a significant yield advantage we think makes sense.

Text on screen: Key investor takeaways: 2. Reduced exposure to long-term lending

Images on screen: Stock market ticker tape

Number two, we're concentrating the bulk of our interest rate exposure in the front end of the yield curve. We're a bit more hesitant to lend long term, both because we do think inflation will be a greater risk, and we do think that sustainability issues will remain in focus. So we'd like to concentrate our interest rate exposure in that five-to-ten-year part of the curve. And also, we're not wildly overweight interest rate risk. We're back to neutral and even some of our more flexible strategies, we're still running a pretty significant underweight.

And then also, even though our base case view is that inflation will likely remain in that 2.5% type zone and even potentially trend lower over time,

Text on screen: Key investor takeaways: 3. Inflation protection

Images on screen: Pumping gas into a car

inflation protection is very, very attractive. Whether you're looking at Treasury inflation protected securities or other types of fixed income inflation protection, or you're looking at commodity values at historical context, the cost to insure against inflation still is quite low, and across most of our diversified strategies, we have a pretty solid allocation or overweight to inflation protected securities.

Text on screen: Key investor takeaways: 4. Liquidity

Images on screen: PIMCO trade floor

Last but not least, liquidity or flexibility. We think this is an environment where running more liquidity, all else equal, provides flexibility in a world with more political uncertainty, especially on the debt side. We just think it makes a lot of sense to have flexibility to respond to what will likely be an environment of ongoing volatility.

So those are the things that we're doing. It's a risk. We think it's a manageable risk. And in some sense, higher debt is not bad for the end investor because the US government's forced to borrow at a higher yield. And of course, we and our clients are the beneficiaries of higher real rates than would be the case otherwise. Practical limits. Sure, you don't want it to get too out of control, but we do think again, this is partially why we're able to source better value, and still a pretty high-quality segment of the fixed income markets.

Text on screen: For more insights and information visit pimco.com

Text on screen: PIMCO

Disclosure

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. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Equities may decline in value due to both real and perceived general market, economic and industry conditions.

This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

PIMCO as a general matter provides services to qualified institutions, financial intermediaries and institutional investors. Individual investors should contact their own financial professional to determine the most appropriate investment options for their financial situation. This is not an offer to any person in any jurisdiction where unlawful or unauthorized. | Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660 is regulated by the United States Securities and Exchange Commission. | PIMCO Europe Ltd (Company No. 2604517, 11 Baker Street, London W1U 3AH, United Kingdom) is authorised and regulated by the Financial Conduct Authority (FCA) (12 Endeavour Square, London E20 1JN) in the UK. The services provided by PIMCO Europe Ltd are not available to retail investors, who should not rely on this communication but contact their financial adviser.. Since PIMCO Europe Ltd services and products are provided exclusively to professional clients, the appropriateness of such is always affirmed. | PIMCO Europe GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Europe GmbH Italian Branch (Company No. 10005170963, via Turati nn. 25/27 (angolo via Cavalieri n. 4), 20121 Milano, Italy), PIMCO Europe GmbH Irish Branch (Company No. 909462, 57B Harcourt Street Dublin D02 F721, Ireland), PIMCO Europe GmbH UK Branch (Company No. FC037712, 11 Baker Street, London W1U 3AH, UK), PIMCO Europe GmbH Spanish Branch (N.I.F. W2765338E, Paseo de la Castellana 43, Oficina 05-111, 28046 Madrid, Spain) and PIMCO Europe GmbH French Branch (Company No. 918745621 R.C.S. Paris, 50–52 Boulevard Haussmann, 75009 Paris, France) are authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 15 of the German Securities Institutions Act (WpIG). The Italian Branch, Irish Branch, UK Branch, Spanish Branch and French Branch are additionally supervised by: (1) Italian Branch: the Commissione Nazionale per le Società e la Borsa (CONSOB) (Giovanni Battista Martini, 3 - 00198 Rome) in accordance with Article 27 of the Italian Consolidated Financial Act; (2) Irish Branch: the Central Bank of Ireland (New Wapping Street, North Wall Quay, Dublin 1 D01 F7X3) in accordance with Regulation 43 of the European Union (Markets in Financial Instruments) Regulations 2017, as amended; (3) UK Branch: the Financial Conduct Authority (FCA) (12 Endeavour Square, London E20 1JN); (4) Spanish Branch: the Comisión Nacional del Mercado de Valores (CNMV) (Edison, 4, 28006 Madrid) in accordance with obligations stipulated in articles 168 and 203 to 224, as well as obligations contained in Tile V, Section I of the Law on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217/2008, respectively and (5) French Branch: ACPR/Banque de France (4 Place de Budapest, CS 92459, 75436 Paris Cedex 09) in accordance with Art. 35 of Directive 2014/65/EU on markets in financial instruments and under the surveillance of ACPR and AMF. The services provided by PIMCO Europe GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication. According to Art. 56 of Regulation (EU) 565/2017, an investment company is entitled to assume that professional clients possess the necessary knowledge and experience to understand the risks associated with the relevant investment services or transactions. Since PIMCO Europe GMBH services and products are provided exclusively to professional clients, the appropriateness of such is always affirmed. | PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2, Brandschenkestrasse 41 Zurich 8002, Switzerland). According to the Swiss Collective Investment Schemes Act of 23 June 2006 (“CISA”), an investment company is entitled to assume that professional clients possess the necessary knowledge and experience to understand the risks associated with the relevant investment services or transactions. Since PIMCO (Schweiz) GmbH services and products are provided exclusively to professional clients, the appropriateness of such is always affirmed. The services provided by PIMCO (Schweiz) GmbH are not available to retail investors, who should not rely on this communication but contact their financial adviser. | PIMCO Asia Pte Ltd (8 Marina View, #30-01, Asia Square Tower 1, Singapore 018960, Registration No. 199804652K) is regulated by the Monetary Authority of Singapore as a holder of a capital markets services licence and an exempt financial adviser. The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Asia Limited (Suite 2201, 22nd Floor, Two International Finance Centre, No. 8 Finance Street, Central, Hong Kong) is licensed by the Securities and Futures Commission for Types 1, 4 and 9 regulated activities under the Securities and Futures Ordinance. PIMCO Asia Limited is registered as a cross-border discretionary investment manager with the Financial Supervisory Commission of Korea (Registration No. 08-02-307). The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Investment Management (Shanghai) Limited. Office address: Suite 7204, Shanghai Tower, 479 Lujiazui Ring Road, Pudong, Shanghai 200120, China (Unified social credit code: 91310115MA1K41MU72) is registered with Asset Management Association of China as Private Fund Manager (Registration No. P1071502, Type: Other). | PIMCO Australia Pty Ltd ABN 54 084 280 508, AFSL 246862. This publication has been prepared without taking into account the objectives, financial situation or needs of investors. Before making an investment decision, investors should obtain professional advice and consider whether the information contained herein is appropriate having regard to their objectives, financial situation and needs. To the extent it involves Pacific Investment Management Co LLC (PIMCO LLC) providing financial services to wholesale clients, PIMCO LLC is exempt from the requirement to hold an Australian financial services licence in respect of financial services provided to wholesale clients in Australia. PIMCO LLC is regulated by the Securities and Exchange Commission under US laws, which differ from Australian laws. | PIMCO Japan Ltd, Financial Instruments Business Registration Number is Director of Kanto Local Finance Bureau (Financial Instruments Firm) No. 382. PIMCO Japan Ltd is a member of Japan Investment Advisers Association, The Investment Trusts Association, Japan and Type II Financial Instruments Firms Association. All investments contain risk. There is no guarantee that the principal amount of the investment will be preserved, or that a certain return will be realized; the investment could suffer a loss. All profits and losses incur to the investor. The amounts, maximum amounts and calculation methodologies of each type of fee and expense and their total amounts will vary depending on the investment strategy, the status of investment performance, period of management and outstanding balance of assets and thus such fees and expenses cannot be set forth herein. | PIMCO Taiwan Limited is an independently operated and managed company. The reference number of business license of the company approved by the competent authority is (112) Jin Guan Tou Gu Xin Zi No. 015 . The registered address of the company is 40F., No.68, Sec. 5, Zhongxiao East Rd., Xinyi District, Taipei City 110, Taiwan (R.O.C.), and the telephone number is +886 2 8729-5500. | PIMCO Canada Corp. (199 Bay Street, Suite 2050, Commerce Court Station, P.O. Box 363, Toronto, ON, M5L 1G2) services and products may only be available in certain provinces or territories of Canada and only through dealers authorized for that purpose. | Note to Readers in Colombia: This document is provided through the representative office of Pacific Investment Management Company LLC located at Carrera 7 No. 71-52 TB Piso 9, Bogota D.C. (Promoción y oferta de los negocios y servicios del mercado de valores por parte de Pacific Investment Management Company LLC, representada en Colombia.). Note to Readers in Brazil: PIMCO Latin America Administradora de Carteiras Ltda.Av. Brg. Faria Lima, 3477 Itaim Bibi, São Paulo - SP 04538-132 Brazil. Note to Readers in Argentina: This document may be provided through the representative office of PIMCO Global Advisors LLC AVENIDA CORRIENTES, 299, Buenos Aires, Argentina. | No part of this publication may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America LLC in the United States and throughout the world. ©2024, PIMCO.

CMR2024-1118-4026375