PIMCO Smiles On Bonds In Uncertain Times

Amanda Cheesley Deputy Editor 11 January 2024

PIMCO Smiles On Bonds In Uncertain Times

The views of the firm, with $1.74 trillion in AuM at the end of December, carry weight.

Bonds offer attractive yields and show resilience against different economic conditions, PIMCO, one of the world's largest fixed income managers says. 

That is the view from Tiffany Wilding, economist, and Andrew Balls, chief investment officer of global fixed income at the US firm. After major economies showed surprising resilience in 2023, Wilding and Balls expect a downshift towards stagnation or mild contraction this year. They think that the standout strength of the US is likely to fade over the firm’s six to 12-month cyclical horizon.

“Countries with more rate-sensitive markets will likely slow more markedly,” they said in a note, called Navigating The Descent. “With inflation easing, developed market central banks have likely reached the end of their hiking cycles. That has shifted attention to the timing and pace of eventual rate cuts,” they continued.

Historically, central banks do not tend to cut rates ahead of downturns, instead easing only after recessionary conditions appear and then making more cuts than markets anticipate. In the longer term, they expect neutral policy rates to decline to levels similar to, or slightly above, those seen before the pandemic.

As indicated by US Federal Reserve Chair Jerome Powell, Wilding and Balls think upside risks around inflation and downside risks to growth have become more symmetrical. However, recession risks remain elevated, in their view, due to stagnant supply and demand growth across developed markets. “After a rally across many financial markets in late 2023, riskier assets appear priced for an economic soft landing and may be underestimating both upside and downside risks,” they said.

The firm, like many of its peers, is setting out asset allocation ideas at the start of a year, and a general risk aversion appears to be a common theme. Other wealth managers also favour quality bonds in 2024. UK wealth manager Brown Shipley, Paris-based asset manager Carmignac, HSBC Global Private Banking, UBS Global Wealth Management see value in quality bonds in 2024. See more here and here.

With $1.74 trillion of assets under management at the end of 2023, PIMCO's managers carry weight when talking about asset allocation.

With attractive valuations and yields still near 15-year highs, Wilding and Balls think fixed income markets can offer an array of opportunities and weather different macroeconomic outcomes.

In credit markets, Wilding and Balls continue to favour US agency mortgage-backed securities and other high-quality assets backed by collateral, which offer both attractive yields and downside resiliency.

In corporate credit, they like liquid credit indices, senior financial sector debt, and high-quality positions in investment grade and high yield bonds, while being cautious on lower-quality credit and more economically sensitive sectors such as floating-rate bank loans.

The trend of banks stepping away from certain types of lending will likely persist and afford opportunities in asset-based and specialised finance in private markets.

Wilding and Balls also see appealing opportunities globally, with the potential to outperform US bonds based on greater downside economic risks. They are focused on more liquid developed markets given attractive yields, but they also expect to find good opportunities in emerging markets, both in terms of local and external debt. They expect to be overweight emerging market foreign exchange, with diversified funding currencies to reduce the correlation between higher-carry emerging market currencies and global risk assets.

Although cash yields remain elevated, investors can miss out by sitting on cash for too long, they think. “The bond market rally in late 2023 highlighted how investors can achieve more attractive total return in high quality, medium-term bonds – through the combination of yield and price appreciation – without taking on greater interest rate risk in long-dated bonds,” they said.

Wilding and Balls expect to be broadly neutral on duration after the most recent bond market rally, which has brought global yields back in line with their expected ranges, and amid the shifting balance of inflation and growth risks.

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