"The market’s repricing makes us very optimistic", say investment managers at Pimco, as they outline where the opportunities lie in a market that has seen volatility and uncertainty drive a sell-off in the second quarter of this year.
Bonds have had a rocky start to the year amid rising inflation and interest rates followed by a growing threat of recession both at home and abroad.
Added to this is the threat of stagflation in major economies, which would see inflation remain at higher levels in the near term alongside slowing economic growth.
In a Q&A with FTAdviser In Focus, in partnership with Pimco, the asset manager's investment team explains what weighs heavily on their mind at the moment and how the Pimco GIS Income Fund seeks out opportunities in the market right now.
FTA: What occupies the minds of your investment committee these days – inflation or the prospect of a recession?
Pimco: A combination of both. Recent macro data underscore our view that the war in Ukraine and sanctions shock, along with the Covid-19-related lockdowns in China, is stagflationary.
Our base case view is that US inflation likely peaked in June but will remain elevated well into 2023, perhaps even 2024, before it trends down toward central bank targets.
Although prices of some key commodities are declining and other price pressures have begun to dissipate, we believe inflation will remain a significant risk factor for investors, driven by uncertainty around the war in Ukraine, other geopolitical risks, and the evolution of Covid.
There is also an increasing trade-off between central bank tightening to contain inflation and resulting weakness in economic growth, employment, and credit fundamentals. This trade-off makes a minor-to-moderate recession increasingly likely and impacts our views on interest rate and credit exposure.
We see an elevated risk of recession in the near term – reflecting geopolitical tumult – stubbornly high inflation that reduces households’ real disposable income, and central banks’ intense focus on fighting inflation first.
FTA: As yields are rising, how can investors know when is the right time to return to fixed income?
Pimco: We know in a world like today where there is so much uncertainty it is hard to time an entry point perfectly, but value from a longer-term historical perspective has returned to the market.
The yield on core bond benchmarks has recovered from Covid-era lows, and in our baseline outlook we think that forward markets either price in or are close to pricing in what is likely to be the secular high for policy rates across different countries.
The volatility we have witnessed is creating the type of opportunity across sectors where not only can you generate an attractive yield without going down the credit spectrum too significantly, but you can also take advantage of a lot of this local volatility and provide some incremental pickup through relative value trading, through targeting even more resilient sectors.