Balancing Risks and Opportunities in the Multi-Speed World - PIMCO

7/24/2019 Balancing Risks and Opportunities in the Multi-Speed World - PIMCO

1/8

CYCLICAL OUTLOOK

Te past several months have

investors and policymakers

reassessing global economic

prospects amid elevated

concerns over emergingmarket growth models

and policy effectiveness.

In the midst of these global

uncertainties, PIMCO

investment professionals

gathered recently for our

September Cyclical Forum.

Balancing Risks andOpportunities in theMulti-Speed World


2/8

2 September 2015 Cyclical Outlook

Although the turbulence in global markets that ollowed the bursting o the Chinese equity

bubble in June and the allout rom the devaluation o the Chinese yuan in August was the

major financial event that has occurred since our March orum, our goal at the September

orum as at every orum was to look ahead rom initial conditions so as to ormulate a

baseline view or the global economy as well as to identiy and assess the balance o risks to

that baseline view. Our orum discussions benefited enormously rom the active participation

o and valuable contributions rom PIMCO senior advisors Ben Bernanke, Mike Spence and

Gene Sperling. Drawing on superb presentations rom our Americas, European, and Asia-Pacific portolio committees, as well as rom our emerging market (EM) team, and ollowing

a very robust and wide-ranging internal discussion, we coalesced on a baseline view that

global economic prospects over the next months remain broadly unchanged from where we

saw them in March and are consistent with global GDP growth in the range of .% to % and

global inflation of % to .%.

While this is our baseline cyclical view, the averages it represents mask significant and in

some cases widening divergences among the worlds major economies. As we shall discuss

urther below, our baseline view or GDP growth in the U.S., eurozone, U.K. and Japan over

the next year is actually consistent with a modest increasein the pace o growth or this group

AUTHORS

Richard Clarida

Global Strategic Advisor

Andrew Balls

Chief Investment Officer,Global Fixed Income

At our previous Cyclical Forum in March , weconcluded (as detailed in our post-forum essay)

that the global economy was Riding a Wave of

Accommodation Carefully. Since then, while

the wave of global monetary accommodation

has if anything expanded in scale and in scope

and may well deepen further over our cyclicalhorizon to date it has been insufficient to stave

off a decline in commodity and equity prices or

to discourage renewed fears of disinflation amid

concerns that China will not be able to navigate

the New Normal trajectory for growth and global

financial integration they have set for themselves.


3/8

3September 2015 Cyclical Outlook

PIMCOs investment process is

anchored by our Secular and

Cyclical Economic Forums. Four

times a year, our investment

professionals from around the

world gather in Newport Beach to

discuss and debate the state of the

global markets and economy and

identify the trends that we believe

will have important investment

implications going forward. We

believe a disciplined focus onlong-term fundamentals provides

an important macroeconomic

backdrop against which we can

identify opportunities and risks and

implement long-term investment

strategies. At the Secular Forum,

held annually, we focus on the

outlook for the next three to five

years, allowing us to position

portfolios to benefit from structural

changes and trends in the global

economy. At the Cyclical Forum,

held three times a year, we focus

on the outlook for the next six to

12 months, analyzing business cycle

dynamics across major developed

and emerging market economies

with an eye toward identifying

potential changes in monetary and

fiscal policies, market risk premiums

and relative valuations that drive

portfolio positioning.

United States

2.25% to 2.75%

BRIM2.0% to 3.0%

BRIM is Brazil, Russia,India, Mexico

United Kindgom

2.25% to 2.75%

Eurozone1.5% to 2.0%

China

5.5% to 6.5%

Japan1.25% to 1.75%

ABOUT OUR FORUMSGROWTH OUTLOOK FOR THE NEXT 12 MONTHS (GDP RANGE)

FORECAST REAL GDP HEADLINE INFLATION

Current* Q315Q316 Current* Q315Q316

United States 2.7% 2.25% to 2.75% 1.8% 1.75% to 2.25%

Eurozone 1.5% 1.5% to 2.0% 0.2% 1.0% to 1.5%

United Kingdom 2.6% 2.25% to 2.75% 0.0% 1.25% to 1.75%

Japan 0.8% 1.25% to 1.75% 0.6% 1.0% to 1.5%

China 7.0% 5.5% to 6.5% 1.5% 1.5% to 2.5%

BRIM** 0.3% 2.0% to 3.0% 8.4% 5.0% to 6.0%

World*** 2.7% 2.5% to 3.0% 2.1% 2.0% to 2.5%

*Current data for real GDP and inflation represent four quarters ending Q2 2015

**BRIM is Brazil, Russia, India, Mexico

***World is the GDP-weighted average of countries listed in table above

Source: Bloomberg, PIMCO calculations.


4/8


o countries versus the past year.On the other side o the ledger, we

concluded that prospects or

growth in China are clearly

deteriorating, though we note the

market consensus view is

converging toward PIMCOs more

bearish orecast published in

March, which in act remains

roughly unchanged. Finally, other

major emerging economies such as

Russia and Brazil find themselves

at present in recession with at best

uncertain prospects or recovery

over our cyclical horizon.

In terms o policy, although more

than central banks have eased

monetary policy thus ar in ,

the odds or additional monetary

easing by the European Central

Bank (ECB) and the Peoples Bank

o China (PBOC) are material, and

urther easing by the Bank o Japan(BOJ) is certainly possible. As or

the Federal Reserve, while our

baseline view remains that it will

commence a rate hike cycle

sometime over our one-year

cyclical horizon, the pace o lifoff

is likely to be even more gradual

than we expected in March.

Moreover, as our new and already

valued colleague Joachim Fels

reminded us, there is a chance that

the Fed, like a number o central

banks in recent years, may find it

impossible to escape the effective

lower bound to which policy rates

were cut during the dark days o

the crisis some seven years ago.

As or global inflation, we see

prospects or a modest pickup in

inflation in many countries as the

pass-through o lower oil prices and in the case o the U.S., the

stronger dollar on price indexes

ades. By contrast, in Brazil and

Russia, where inflation well

exceeds target, recession and (in

Brazil) tight monetary policy are

expected to bring inflation lower

over our cyclical horizon.

In short, we find ourselves today

and or some time are likely to

remain in a multi-speed world orgrowth, inflation and economic

policy; a multi-speed world that is

indeed one o the key elements o

PIMCOs secular New Neutral

thesis. Below is our more detailed

economic outlook or this multi-

speed world over the next

months, and then a discussion o

some o the key investment

implications that flow rom it.

U.S. Outlook

For the U.S., our baseline view sees

economic growth in the range o

.% to .% over the next our

quarters and CPI inflation o .%

to .%. Tis baseline represents a

modest pickup in growth and

inflation relative to the pace

recorded in the first hal o ,

and it is slightly below the pace o

GDP growth over the most recent

our quarters. Projected

employment and labor income

gains should support consumption,

while historically low mortgage

rates and a pent-up demand or

housing driven by household

ormation and demography should

boost residential construction. In

contrast to robust consumption

and housing, business investmentconronts the headwinds rom low

oil prices and cutbacks in drilling

and exploration, while exports will

be challenged by the delayed effects

o a stronger dollar and slower

growth in emerging economies. As

or the Fed, one consequence o the

summer sell-off triggered by

surprise devaluation o the

Chinese yuan (CNY) on August

has been to lower the odds that we

get a hawkish mistake rom the

Fed. While the Yellen put

analogy is imprecise i there is a

put, then where is the strike, and

is this Fed really prepared to

deploy its balance sheet to deend

it? it is clear rom their

statements that this Fed is alert to

the state o financial conditions

and is inclined to go slow once it

starts to hike so as to avoid

tightening too much.

Eurozone and U.K. Outlook

For the eurozone, our baseline sees

economic growth o .% to .%

over the next our quarters with

inflation in a range o % to .%.

Tis baseline also represents a

modest pickup in growth and

inflation relative to the paces

recorded in recent quarters. Unlike

the U.S., the eurozone hasbenefited rom a weaker currency

and rom low oil prices, and the

tailwinds rom low oil prices and

the weaker euro currency should

support aggregate demand in the

year ahead. And or the first time

in several years, fiscal policy is no

longer projected to be a drag on

eurozone aggregate demand.


5/8


Moreover, the ECB is gainingtraction in transmitting the thrust

o accommodative monetary

policy to easier credit conditions.

On ECB policy, we see a significant

probability that the current

quantitative easing (QE) program

gets expanded beore its scheduled

conclusion in September . As

or the U.K, we are projecting GDP

growth o .% to .% with

inflation running in a range o

.% to .%. Te U.K. economy

is supported by a strong labor

market and the wealth effect rom

robust house prices benefiting

rom low interest rates. With

prospects or the eurozone

improving, U.K. exports should

also contribute to growth. As Mike

Amey (sterling portolio manager

on our European portolio

committee) reminded us, this is a

typical U.K. business cycle, and

one that is not threatened by

above-target inflation. I the Bank

o England does hike during our

horizon, it will almost certainly be

afer the first Fed hike, and not

until sometime in .

China Outlook

In previous orums, weve

concluded that China possesses the

will and the wallet to deal with thepolicy challenges it aces as it

transitions rom a development

model based on running huge

current account surpluses with

a closed capital account to a

model based more on domestic-

demand-supported growth and a

more internationally open capital

market. While this continues to be

true, recent events require us to aski will and wallet continue to be

sufficient. Tis assessment is a task

that will take us (and the markets)

some time to complete, and at the

September orum we only just

began the process. Clearly, the

challenges acing China today are

substantial. Te economy conronts

a property bust, a collapse in equity

prices, alling exports and an over-

levered shadow banking system.

Hot money capital is fleeing

China, and the central bank

(PBOC) is losing reserves in an

effort to prevent a urther

uncontrolled depreciation o the

CNY exchange rate. Under these

circumstances, our baseline sees

GDP growth in China in a range o

.% to .% over the next our

quarters, which is little changed

rom our March orecast but

remains well below consensus. We

see inflation in the range o .% to

.%. In the ace o such challenging

economic circumstances, we expect

to see a significant monetary policy

response rom the PBOC, with

basis points in deposit rate cuts, a

basis point cut in the required

reserve ratio and devaluation o the

CNY to a level o . to the dollar.

Japan OutlookTe Japanese economy has suffered

rom the slowdown in China and

the continuing drag rom the

hike in the VA. Corporate profits

are healthy due to the weaker yen

and the labor market is robust, but

Japan aces significant structural

headwinds to trend growth that

have not yet been offset by the

third arrow o Abenomics (thefirst two arrows were fiscal

stimulus and monetary easing;

structural reorm is the third). Te

Bank o Japan remains extremely

accommodative with its massive

Quantitative and Qualitative

Monetary Easing (QQE) program

in place, yet inflation is projected

to rise only modestly. Our baseline

view is that GDP growth in Japan

should rise rom an outright

decline in the second quarter, but

only up to a range o .% to .%

over the next our quarters. Under

this scenario, we see a possibility

that over our cyclical horizon the

BOJ expands yet again the QQE

program, as there is a limited

prospect that inflation reaches the

% target desired by BOJ Governor

Haruhiko Kuroda.

Brazil and Russia Outlook

In Brazil, the macro outlook will

largely be a derivative o domestic

politics as the gridlock in Congress

continues. We are orecasting the

recession to deepen throughout

this year with meaningul

downside risks as business

confidence and investment remain

weak. At the same time, we expect

inflation will remain high but start

to noticeably decline in the firstquarter o . Potential upside

risks to inflation could arise rom

the outcome o wage negotiations

in the all, a weaker currency and

urther fiscal slippage; downside

risks could arise rom a deep

disinflation rom the recession and

lower energy prices. Given this

backdrop, we expect only a modest


6/8


Te current account surplus hasbeen improving, and the

deleveraging by the corporate

sector has been impressive, i only

out o necessity.

Risks to the Baseline View

All probability distributions have

right as well as lef tails. oday, the

most significant lef tail risk to the

global economic outlook is or a

hard landing in China, which inthe extreme could trigger a

currency war and could increase

the odds o outright global

deflation. Tis is not our base case,

in no small part because we project

significant policy easing by the

PBOC over the next year as they

seek to clip this lef tail risk.

On the optimistic side, thus ar the

positive stimulus to global

aggregate demand rom low oilprices has been less than projected

by the Organisation or Economic

Co-operation and Development,

the International Monetary Fund

and other experts. I in act the

stimulus rom low oil prices

has only been delayed, not

overestimated, global growth

in the year ahead could surprise on

the upside.

Overall, we see the balance o risksto the global economy tilted

somewhat to the downside, in part

because o diminishing returns o

unconventional monetary policy

and also the market volatility

stemming rom developments

in China.

rate-cutting cycle in as long asthe political backdrop is stable and

currency pressures are contained.

In addition, we expect to see

pressures on Brazils sovereign

external ratings ollowing S&Ps

downgrade to high yield (with

negative outlook) as the political

dysunction continues and near-

term prospects o fiscal

consolidation and circuit breakers

remain slim. In Russia, the

recession continues unabated and

is set to peak in the third quarter o

(in year-over-year terms) on

the back o a negative terms-o-

trade shock and amid the weight o

Western sanctions. PIMCO

expects Russias GDP to contract

between .% and % this year,

and around .% in .

Domestic demand remains the

main drag to growth, with

household spending in particular

being hit under a sharp contraction

in real wages. Capital expenditures

are set to become the main

detractor to growth going orward

once the pressure on real wages

subsides. Meanwhile, the

disinflation trend is set to continue

as the impact rom the rubles

weakness has been relatively

contained, i.e., not validated by

wage growth. We expect Russiascentral bank to continue to cut

interest rates but to moderate the

pace o easing going orward. Te

mirror image (and the silver

lining) o the recession in domestic

demand has been the improvement

in Russias external balance sheet.


7/8


INVESTMENT IMPLICATIONS

While our baseline views on the

global macro outlook have not

changed significantly, we see

somewhat higher macro and in

particular market risk. o the extent

that there is an impact on macro

variables rom the market volatility,

we expect that central banks will

respond over the cyclical path,

including a slower pace o hikes by

the Fed and increased QE rom the

BOJ and the ECB. As the Federal

Reserve noted in its statement

ollowing its September meeting

just afer our Cyclical Forum

while most o the FOMC

members expect to raise interest

rates beore the end o this year,

global developments have raised the

risks to the U.S. outlook or growth

and inflation in the near term.

At the same time, we see central

banks migrating rom being a

source o endogenous stability in

markets to being a source o some

exogenous instability. Te

willingness to attempt to suppress

volatility is there, but the ability to

do so is diminished. Over-reliance

on central banks (versus fiscal/

structural policy) has led to a wedge

between market valuations and

undamentals that requires a careul

approach to portolio constructionand close attention to correlated

risk positions and stress tests.

In broad terms, we see global fixed

income markets as anchored by our

New Neutral secular ramework or

interest rates. Lower central bank

policy rates over the next three to

five years mean that fixed income

markets look air to somewhat rich

but not grossly mispriced.

In terms o portolio positioning,

this translates into modest duration

underweights or the most part. We

expect markets to price more risk

premiums into developed country

curves, starting with the U.S. and

the Fed rate hike cycle.

We think that markets are probably

pricing insufficient tightening by

the Fed, based upon our baseline

orecast o above-potential growthand inflation getting back to the

Feds % target over the next our

quarters. Globally, we see the same

pattern o orward rates that look

air to slightly rich in nominal

duration. In U.S. reasury

Inflation-Protected Securities

(IPS), we see valuation as

attractive, given our expectation

or gradually rising inflation.

We continue to expect to maintainbroad credit spread overweights in

our portolios, with some

increased uncertainty in the

outlook compensated or by more

attractive valuations ollowing

recent market weakness. We

continue to see investment grade

and high yield credit industrials

and financials as attractive. We will

be vigilant on liquidity and ensure

appropriate new issue premiumsare on offer beore adding in

primary markets.

We continue to see value in

non-agency mortgages given

housing market strength, broadly

range-bound rate markets, and the

airly deensive nature o the

securities due to seniority in the

capital structure.

On currencies, we will maintain anoverweight to the U.S. dollar,

reflecting macro and policy

divergence at a time when the U.S.

economy is outperorming and the

Fed is set to tighten policy, while

we expect ongoing policy

loosening outside the U.S. We will

avor a diversified basket o

unding currencies, G-

currencies and Asian emerging

market currencies.

We will be cautious on emerging

markets holdings, reflecting macro

and market risks, but will continue

to look or select opportunities to

add risk at attractive valuations.

On global equities, we are broadly

neutral overall. At a time o

peaking U.S. profits and a

stronger U.S. dollar, we will

continue to avor European and

Japanese equities based onearnings growth momentum and

supportive central banks.

On commodities, we expect to see

supply and demand as broadly

balanced over the next months

and have a neutral outlook at

current prices.

We see central banksmigrating from being asource of endogenousstability in markets tobeing a source of someexogenous instability.



8/8

All investmentscontain risk and may lose value. Investing in the bond market is subject to risks, including market, interestrate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes ininterest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorterdurations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk.Current 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.High yield, lower-rated securitiesinvolve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit andliquidity risk than portfolios that do not. Inflation-linked bonds (ILBs) issued by a government are fixed income securitieswhose principal value is periodically adjusted according to the rate of inflation; ILBs decline in value when real interest ratesrise. Treasury Inflation-Protected Securities (TIPS)are ILBs issued by the U.S. government. Mortgage- and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and while generallysupported by a government, government-agency or private guarantor, there is no assurance that the guarantor will meet itsobligations. Investing in foreign-denominated and/or -domiciled securitiesmay involve heightened risk due to currencyfluctuations, and economic and political risks, which may be enhanced in emerging markets. Currency rates may fluctuatesignificantly over short periods of time and may reduce the returns of a portfolio. Equities may decline in value due to bothreal and perceived general market, economic and industry conditions.Commoditiescontain heightened risk, includingmarket, political, regulatory and natural conditions, and may not be suitable for all investors. The above strategy overview isintended to illustrate major themes for the identified period. No representation is being made that any particular account,product or strategy will engage in all or any of the above themes. Investors should consult their investment professional prior

to making an investment decision.This material contains the opinions of the manager and such opinions are subject to change without notice. This material hasbeen distributed for informational purposes only. Forecasts, estimates and certain information contained herein are basedupon proprietary research 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, butnot guaranteed.

PIMCO provides services only to qualified institutions and investors. This is not an offer to any person in any jurisdictionwhere unlawful or unauthorized. | Pacific Investment Management Company LLC, 650 Newport Center Drive, NewportBeach, CA 92660 is regulated by the United States Securities and Exchange Commission. | PIMCO Investments LLC, U.S.distributor, 1633 Broadway, New York, NY, 10019 is a company of PIMCO. | PIMCO Europe Ltd(Company No. 2604517),PIMCO Europe, Ltd Amsterdam Branch (Company No. 24319743), and PIMCO Europe Ltd - Italy (Company No.07533910969) are authorised and regulated by the Financial Conduct Authority (25 The North Colonnade, Canary Wharf,London E14 5HS) in the U.K. The Amsterdam and Italy branches are additionally regulated by the AFM and CONSOB inaccordance with Article 27 of the Italian Consolidated Financial Act, respectively. PIMCO Europe Ltd services and products areavailable only to professional clients as defined in the Financial Conduct Authoritys Handbook and are not available toindividual investors, who should not rely on this communication. | PIMCO Deutschland GmbH(Company No. 192083,Seidlstr. 24-24a, 80335 Munich, Germany) is authorised and regulated by the German Federal Financial SupervisoryAuthority (BaFin) (Marie-Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 32 of theGerman Banking Act (KWG). The services and products provided by PIMCO Deutschland GmbH are available only toprofessional clients as defined in Section 31a para. 2 German Securities Trading Act (WpHG). They are not available toindividual investors, who should not rely on this communication. | PIMCO (Schweiz) GmbH(registered in Switzerland,Company No. CH-020.4.038.582-2), Brandschenkestrasse 41, 8002 Zurich, Switzerland, Tel: + 41 44 512 49 10. The servicesand products provided by PIMCO Switzerland GmbH are not available to individual investors, who should not rely on thiscommunication but contact their financial adviser. |PIMCO Asia Pte Ltd(501 Orchard Road #09-03, Wheelock Place,Singapore 238880, Registration No. 199804652K) is regulated by the Monetary Authority of Singapore as a holder of acapital markets services licence and an exempt financial adviser. The asset management services and investment products arenot 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 andFutures Commission for Types 1, 4 and 9 regulated activities under the Securities and Futures Ordinance. The assetmanagement services and investment products are not available to persons where provision of such services and products isunauthorised. | PIMCO Australia Pty Ltd ABN 54 084 280 508, AFSL 246862 (PIMCO Australia) offers products andservices to both wholesale and retail clients as defined in the Corporations Act 2001 (limited to general financial productadvice in the case of retail clients). This communication is provided for general information only without taking into accountthe objectives, financial situation or needs of any particular investors. | PIMCO Japan Ltd(Toranomon Towers Office 18F,4-1-28, Toranomon, Minato-ku, Tokyo, Japan 105-0001) Financial Instruments Business Registration Number is Director ofKanto Local Finance Bureau (Financial Instruments Firm) No. 382. PIMCO Japan Ltd is a member of Japan InvestmentAdvisers Association and The Investment Trusts Association, Japan. Investment management products and services offeredby PIMCO Japan Ltd are offered only to persons within its respective jurisdiction, and are not available to persons where

provision of such products or services is unauthorized. Valuations of assets will fluctuate based upon prices of securities andvalues of derivative transactions in the portfolio, market conditions, interest rates and credit risk, among others. Investmentsin foreign currency denominated assets will be affected by foreign exchange rates. There is no guarantee that the principalamount of the investment will be preserved, or that a certain return will be realized; the investment could suffer a loss. Allprofits and losses incur to the investor. The amounts, maximum amounts and calculation methodologies of each type of feeand 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 Canada Corp.(199 Bay Street, Suite 2050, Commerce Court Station, P.O. Box 363, Toronto, ON, M5L 1G2) servicesand products may only be available in certain provinces or territories of Canada and only through dealers authorized for thatpurpose. | PIMCO Latin AmericaEdifcio Internacional Rio Praia do Flamengo, 154 1o andar, Rio de Janeiro RJ Brasil22210-906. | No part of this material may be reproduced in any form, or referred to in any other publication, without expresswritten permission. PIMCO is a trademark or registered trademark of Allianz Asset Management of America L.P. in the UnitedStates and throughout the world. THE NEW NEUTRAL and YOUR GLOBAL INVESTMENT AUTHORITY are trademarks orregistered trademarks of Pacific Investment Management Company LLC in the United States and throughout the world.2015, PIMCO.

Newport Beach Headquarters650 Newport Center DriveNewport Beach, CA 92660+1 949.720.6000

Amsterdam

Hong Kong

London

Milan

Munich

New York

Rio de Janeiro

Singapore

Sydney

Tokyo

Toronto

Zurich

pimco.com

blog.pimco.com

PC083_150976

15-0976-GBL

Documents

Balancing Risks and Opportunities in the Multi-Speed World - PIMCO