The largest active bond manager in the world says that markets are overly optimistic about central bank’s ability to avoid a recession while they fight inflation in Europe and the US.
Daniel Ivascyn is the chief investment officer of Pimco. The company manages $1.8tn in assets. He said that he prepared for a “harder land” than most investors, while central bankers prepare to continue raising interest rates.
Ivascyn stated in an interview that the more people tighten their belts, the more uncertain it becomes about these lags. This increases the risk of more extreme economic forecasts.
He said that in the past when rates rose, it took five to six quarters before the effects were felt.
He said that the market was still too confident about the central banks’ ability to achieve positive outcomes. “We believe the market is overconfident in the central banks’ abilities to reduce policy rates as rapidly as yield curves suggest,” he said.
After criticisms that they were too slow in reacting to the rapid increase of inflation, the US Federal Reserve and the European Central Bank all raised rates rapidly.
The heads of the three countries said that more action will be required if inflationary pressures continue. The Nasdaq Composite index posted its best first half in 40 years on Friday. This was partly due to expectations that US interest rate would soon peak.
Core inflation in the US, Eurozone, and UK has been hovering around 5 percent in recent months. In the UK, it has risen as high as 7.1 percent for the entire year ending in May.
Ivascyn stated: “Today, we have a legitimate inflation problem. Even if the economy weakens, central banks will find it difficult to reduce policy as long as the inflation rate is comfortably above [2 percent] target.
Pimco is repositioning its funds to become “more liquid and defensive” in order to attract investors after a bad year for bond funds 2022.
Ivascyn, the California-based manager who suffered €75bn in outflows during last year’s financial crisis, said that flows have “materially improved”, as investors are now grabbing higher yields. Allianz reported that Pimco attracted €14bn in assets during the first quarter this year.
Ivascyn, who is part of Pimco, said that the group avoids areas in the market which would be vulnerable to a recession.
He is currently focusing on high-quality corporate and government bonds. However, he will wait for the downgrading of company credit ratings, which, he says, will lead to a forced sale in the months and years ahead. He said that now is the time to grab bargains.
He said: “A great opportunity will be to take the advantage of the repricing that is occurring on the public markets, and then wait until the private markets adjust in the coming years. Then you can rotate into this really interesting trade.”
Hold some cash as we believe the next two to three years will be rich in opportunities for higher yielding investments.
He warned that this cycle could be different from previous cycles. The central banks might be reluctant to offer support, for fear that they will fuel rising prices. However, the fact so much risk is now transferred to the private market would only slow down, not stop, the decline in credit valuations.
He said that this could be an old-fashioned cycle, where inflation is high for several years but policymakers do not intervene.
Pimco’s shift to safer bonds is part a larger industry trend towards higher-quality fixed-income assets. Bank of America’s latest survey of funds managers showed that investors have been overweighting investment-grade bonds over their high-yield equivalents since 2008.
Ivascyn, a financial analyst, said that even for investors who don’t think central banks can bring inflation down to the target level, fixed income investments offer the best value in “many years”, and real inflation-adjusted US yields are at levels not seen since global financial crisis.
He said: “You can be very defensive when it comes to interest rate risks, inflation risks, and credit risk while still generating a very, extremely attractive return.”
It’s not the same as saying, “Buy everything and it will be fine.”