Receive free global inflation updates
We’ll send you a myFT Daily Digest email every morning with the latest global inflation news.
The world’s largest active bond fund manager says markets are overly optimistic about central banks’ ability to avoid a recession while fighting inflation in the US and Europe.
Daniel Ivascyn, chief investment officer at Pimco, which manages $1.8 trillion in assets, said he was preparing for a “harder landing” than other investors as top central bank governors prepare to launch their campaign of rate hikes to continue.
“The more tightening people feel motivated to tighten, the greater the uncertainty about these delays and the greater the risk of a more extreme economic outlook,” Ivascyn said in an interview with the Financial Times.
He pointed out that in the past, when interest rates were raised, a delay of five or six quarters before the effect was felt was “the norm”.
“We would argue that the market may still be overconfident in the quality of central bank decisions and their ability to produce positive outcomes,” he said. “We think the market is a bit too optimistic about central banks’ ability to cut interest rates as quickly as yield curves suggest.”
The US Federal Reserve, the European Central Bank and the Bank of England have all been quick to raise interest rates after criticism they were too slow to react as inflation picked up steam.
At a conference in Sintra, Portugal this week, the heads of all three indicated that as long as inflationary pressures persisted, further action was likely needed. On Friday, the Nasdaq Composite stock market index posted its strongest first half in 40 years, in part on expectations that U.S. interest rates were about to peak.
But core inflation, which serves as a measure of underlying price pressures as it ignores volatile food and energy prices, has hovered around 5 percent in the US and eurozone in recent months, while in the UK it has risen as high as 7 .1 percent increase for the year ended May.
Ivascyn said: “Today we have a real legitimate inflation problem. Central banks will likely find it harder to ease monetary policy even if the economy is weakening as long as inflation is well above their levels [2 per cent] Goals.”
Pimco, owned by German insurer Allianz, is repositioning its funds to be “more defensive and liquid” as it pulls out investors in 2022 after a terrible year for bond funds.
The California-based manager saw outflows of €75 billion last year, but Ivascyn said outflows have “improved significantly” as investors took advantage of the higher yields now on offer. According to Allianz, Pimco collected assets worth 14 billion euros in the first quarter of this year.
While Pimco believes a “soft landing” is the most likely outcome for the US economy, Ivascyn said the company is avoiding areas of the market that would be most vulnerable to a recession.
He favors high quality government and corporate bonds for now and is awaiting a downgrade in corporate credit ratings, which he believes will lead to forced sales of instruments such as secured debt obligations in the coming months and years. That will be the time to make bargains, he said.
“A great trade will be to take advantage of the sharp repricing in public markets and then wait for private markets to adjust over the next few years and then take advantage of a really attractive opportunity,” he said.
“Have some cash on hand because we expect the next two to three years to be quite productive for higher yield opportunities.”
However, he warned that this cycle could be different from the previous ones. Central banks may be less willing to provide support for fear of fueling rising prices, while the fact that so much risk has been shifted to private markets would slow, but not prevent, the deterioration in credit ratings.
“This may be more of an old-fashioned cycle that lasts for a few years of high inflation, but policymakers aren’t coming to the rescue,” he said.
Recommended
Pimco’s move to safer bonds is part of a broader industry shift toward higher quality fixed income assets. The latest Bank of America survey of fund managers found that since 2008, investors have been most overweight in investment-grade credit relative to high-yield credit.
Even for investors who don’t think central banks will manage to bring inflation back to target levels, Ivascyn says fixed income offers the best value we’ve seen in “many, many years,” with real inflation-adjusted returns in the US are at a level not seen since the global financial crisis.
“You can be defensive about interest rate risk, inflation risk, credit risk and get a very, very attractive yield,” he said.
“It’s different than saying, ‘Buy anything, everything will be fine.'”
Comments are closed.