Each quarter, PIMCO investment professionals from around the world gather in Newport Beach to discuss the outlook for the global economy and financial markets. In an interview, senior portfolio manager Saumil Parikh discusses PIMCO's cyclical economic outlook for the next six to 12 months. Parikh, who leads the forums, is a managing director, generalist portfolio manager and member of PIMCO's Investment Committee.
Parikh also comments on investment strategies that PIMCO is applying to manage risk and deliver returns amid global uncertainty and shifting growth dynamics.
Q: Could you discuss the economic recovery in the U.S. and whether PIMCO believes it will be a lasting rebound?Parikh: I would first note that, as a baseline, PIMCO continues to foresee a multi-speed global recovery over the next few years, with advanced economies facing muted growth and unusually high unemployment, while systemically important emerging economies continue gradually to close the global income and wealth gap. This forecast is governed by more favorable initial conditions of debts and deficits in emerging markets as well as by the loss of capacity for fiscal stimulus in certain developed nations.
Having said that, there are certain cases where the cyclical outlook deviates somewhat from the secular outlook. Nowhere is this juxtaposition between the secular (three to five years) and cyclical (a year or less) more evident than in the U.S. The country is experiencing a cyclical economic rebound, but its strong durability is uncertain. While endorsing the resilience and innovation of U.S. citizens and the economy, there are concerns about the country's ability to achieve in the short-term "escape velocity" due to the legacy of the global financial crisis and other structural headwinds.
Currently, governmental revenues are not growing fast enough to close deficits in a pro-growth manner, and the private sector continues to deleverage. As a result, the national savings rate has continued to decline as opposed to rise as is customary during a self-sustained recovery. Meanwhile, on the margin, political winds are changing and the next fiscal policy surprise could be contractionary "“ as opposed to the expansionary tax-cut deal of late 2010. And, further, we are concerned about the potential economic drag if oil prices remain elevated.
Bottom line: On a cyclical timeline, and also taking into account the external environment, we continue to forecast a 3.0%"“3.5% real U.S. GDP growth rate for 2011, with risks tilted toward slower growth in 2012.
Q: And will the Federal Reserve extend quantitative easing?Parikh: We do not anticipate that the Fed will add to the total quantity of Treasury purchases this year. If it were to change course, it could taper off the purchases (e.g., so instead of ending abruptly in June, the Fed starts buying less in April or May and stretches out purchases a few months beyond June).
Q: What is PIMCO's outlook for Europe?Parikh: The cyclical outlook for the eurozone and U.K. economies contrasts starkly with that of the U.S. Notwithstanding the favorable developments in Germany, several countries there face headwinds to growth via national austerity measures and the resulting fiscal drag over our cyclical horizon.
In our detailed forum discussion about the internal dynamics of Europe, the core economies are expected to achieve at- or above-potential economic growth due to strong initial conditions of competitiveness and a significant tailwind from emerging market external demand. Also, PIMCO sees a non-trivial probability of fat tails on both ends (positive or negative) for the European economy in 2011, depending on whether the sovereign crisis affecting Greece, Portugal and Ireland can be successfully quarantined before spreading to Spain and Italy.
Q: Turning to Japan, many of us have watched the incredible images of the events and the tragedy inflicted there. Certainly others are commenting on the humanitarian needs; perhaps you could discuss the impact on Japan's economy and if there is hope on that front?Parikh: The images are devastating and point to the massive calamities that have hit that country. Japan's immediate focus is rightly on the enormous human suffering and on rescue operations, as well as containing nuclear-reactor risks.
Japan's leaders have moved swiftly to stem fallout from the earthquake and tsunami on all fronts, including economic. Within days of the disaster, the Bank of Japan injected a record 15 trillion yen ($183 billion) into the world's third-largest economy.
Japan's economic growth rate will likely fall in the immediate aftermath of the natural disasters, but reconstruction activities should have a stimulative impact on growth over time. The loss of inventories and supply-chain disruptions could cause inflation to rise temporarily from very low levels.
Much will depend on the extent of the damage to Japan's infrastructure. We are hoping for the best.
Q: Dramatic events are also sweeping the Middle East "“ is the region a threat to the global economic recovery?Parikh: Certainly we are concerned that the sharp rise in global oil prices, and the threat that supply uncertainties could spur further increases, could lead to negative global growth consequences. A truly severe oil shock could shift our global GDP outlook from a soft landing to a more significant downturn with sharply stagflationary effects. We continue, as with much of the world, to monitor and evaluate the situation closely. The risks are very asymmetric given the starting point of oil prices in 2011.
Q: Let's shift to emerging markets. Does PIMCO still see them as drivers of global growth?Parikh: We expect real economic growth in the major emerging economies of China, Brazil, Russia, India and Mexico to remain at a solid rate during 2011, but lower than 2010 due to fading monetary and fiscal policy tailwinds and some pockets of overheating.
In terms of composition, we see growth across the major emerging markets becoming more balanced, with less reliance on the inventory cycle as well as net trade and capital investments, and marginally more reliance on domestic final consumption as an engine for growth.
The main challenge for the major emerging economies in 2011 is managing the risk of greater overheating in the domestic economies. We judge idle capacity to be negligible and cyclical inflation and cost-push pressures on the rise to a degree that could threaten corporate profits, leading to a larger-than-expected slowdown. Once again, and similar to the U.S. outlook, the level and volatility of oil prices are a major cyclical risk to the emerging market growth outlook.
Q: What is PIMCO's outlook on inflation and interest rates if the situation in the Middle East does not lead to a severe oil shock?Parikh: Setting aside immediate oil shocks, we believe global inflation has cyclically troughed and we see a secular upswing in inflation, which naturally will put upward pressure on interest rates.
We see three key global factors as potentially adding to inflation over a long horizon:
In the near term, we anticipate most, though not all, global central banks are likely to err on the side of allowing inflation to rise above stated or implied targets during 2011. In the U.S., if the economic recovery sputters, the Fed could expand quantitative easing. But further deficit accommodation would pose inflation risks.
Q: Finally, could you discuss how PIMCO is applying its global outlook to its investment strategies?Parikh: Let's begin with inflation, which is a topic clients often ask us about, and how that applies to our investing decisions. Since we see a secular bias to global inflation, we expect fixed income yields to gradually rise; we believe the 20-plus-year secular duration tailwind that previously anchored portfolios is over.
So we have taken down duration in our strategies, moving to shorter maturity securities. For example, while we still have faith in the credit quality of U.S. Treasuries, we feel yields on longer-dated notes and bonds are likely to rise as the Federal Reserve ends its quantitative easing and investors price in growing inflation risks.
We continue to focus on attractive opportunities in other areas in the U.S. and across the globe, including foreign currencies and credits. There are lots of opportunities in this global marketplace. Finally, we are tempering our near-term enthusiasm for U.S. corporate bonds with a long-term outlook that the U.S. economy must eventually address fiscal deficits, rising rates and the potential for higher oil prices and those could all be negative factors for U.S. companies and the bonds they issue.
Thank you, Saumil.
Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, and inflation risk. 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. Currency rates may fluctuate significantly over short periods of time and may reduce the returns of a portfolio. Sovereign securities are generally backed by the issuing government, obligations of U.S. Government agencies and authorities are supported by varying degrees but are generally not backed by the full faith of the U.S. Government; portfolios that invest in such securities are not guaranteed and will fluctuate in value. The credit quality of a particular security or group of securities does not ensure the stability or safety of the overall portfolio.
This article contains the current opinions of the authors but not necessarily those of PIMCO and such opinions are subject to change without notice. This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon 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, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Pacific Investment Management Company LLC, 840 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626. ©2011, PIMCO.
No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. Pacific Investment Management Company LLC, 840 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626. ©2011, PIMCO.
Are you sure you would like to leave?
You are currently running an old version of IE, please upgrade for better performance.
Read Full Article »