High-quality fixed income assets may offer the best return potential in more than a decade along with diversification benefits as a likely recession approaches.
- The bond market offers potential for equity-like returns with less volatility and downside risk compared to the stock market, making it valuable for building resilient portfolios.
- We expect to see policy tightening and bank challenges begin to impact the markets more directly over the next few quarters, slower than past cycles due to the high proportion of consumer and corporate debt locked in at low rates.
- Over the next several years, we expect more pronounced economic cycles with risks skewed to the downside as high sovereign debt levels and hesitancy to reignite inflation will likely to limit policymakers’ willingness and capacity to inject fiscal and monetary stimulus.
The fixed income market’s massive repricing may offer investors in high quality bonds the potential for equity-like returns with resilience in the face of a likely recession. Here, Richard Clarida, global economic advisor, and Dan Ivascyn, group chief investment officer, review PIMCO’s longer-term market outlook with Kimberly Stafford, global head of product strategy. They discuss why PIMCO is patiently focused on high quality assets, while preparing to pivot over the next few years to more economically sensitive or lower-rated areas of the credit markets.
Stafford: What key forces do you expect to affect economies and markets over the secular horizon of three to five years?
Clarida: We expect more aftershocks after a number of acute tensions disrupted financial markets and set off inflation around the world: a once-in-a-lifetime pandemic and a tidal wave of policy stimulus, the invasion of Ukraine, and escalating U.S.-China frictions. Central banks responded with the sharpest rate increases in 40 years, setting off three of the largest bank failures in U.S. history and the collapse of Credit Suisse in Europe. Taken together, these events may have revealed hidden vulnerabilities in the global financial system.
Stafford: What are the implications for fiscal and monetary policy given high debt levels around the world, tighter credit, and the likelihood of recession?
Clarida: Economic volatility will likely rise in the next five years from the relatively smooth decade before the pandemic. Debt-to-GDP ratios have surged in many countries, limiting the capacity of governments to deploy fiscal stimulus, while central bankers, cognizant of quantitative easing’s (QE’s) contribution to today’s inflation, could offer less support in future downturns. Without massive stimulus to buffer downturns, we believe economic cycles will become more pronounced, with risks skewed to the downside.
Ivascyn: We’ve seen a great deal of credit tightening over the last five quarters. Typically, economies respond to tightening with lags. But with so much consumer and corporate debt locked in at low fixed rates, we think it will take longer this cycle for the effects to be felt. We expect to see policy tightening and bank challenges begin to impact the markets more directly over the next few quarters.
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