What to expect when you’re expecting rate cuts
CIO Dan Ivascyn discusses the benefits of locking in today’s elevated bond yields ahead of potential rates cuts around the globe.
How does one invest at a time when economies are diverging, uncertainties are piling up, and the playbook for rate cuts is changing faster than most investors can keep up with?
In this video, we'll explain our base case for interest rates and how the curve has moved much closer to where we have been. With a cutting cycle destined to start imminently for most major economies, we think now is the time to be locking in yields while rates are high and talk of stagflation is in the air. We'll also show you how we are investing across other areas of the global fixed income universe.
Finally, we'll explain our thoughts around the remarkable moves in rates markets and why we think more stable price action is imminent.
Transcript
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, and a lot of economic momentum. And 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 and in the U.K. as an example.
What we think that will do is allow central banks to ease policy outside the U.S., perhaps off cycle, not necessarily in a more synchronised 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 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 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 are even ten, 20% chance type risks that they have to tighten the cycle as well. So a lot of uncertainty.
But what's been great for active fixed income is that the volatility of these less synchronised cycles is providing great opportunities to diversify portfolios and 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 slightly overweight position to interest rate risk across most portfolios we manage. 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 Australia, Canada, and even the U.K. for 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 how 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 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 increased volatility within the equity markets, some geopolitical risks, some spread widening and some interesting 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. 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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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. Equities may decline in value due to both real and perceived general market, economic, and industry conditions. The value of real estate and portfolios that invest in real estate may fluctuate due to: losses from casualty or condemnation, changes in local and general economic conditions, supply and demand, interest rates, property tax rates, regulatory limitations on rents, zoning laws, and operating expenses. Private credit involves an investment in non-publically traded securities which may be subject to illiquidity risk. Portfolios that invest in private credit may be leveraged and may engage in speculative investment practices that increase the risk of investment loss.
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PIMCO
With our launch in 1971 in Newport Beach, California, PIMCO introduced investors to a total return approach to fixed income investing. In the 50 years since, we have continued to bring innovation and expertise to our partnership with clients seeking
Expertise
PIMCO
With our launch in 1971 in Newport Beach, California, PIMCO introduced investors to a total return approach to fixed income investing. In the 50 years since, we have continued to bring innovation and expertise to our partnership with clients seeking
Expertise
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