- Preserving capital top priority in three-to-five year outlook
- Central bankers face diminishing returns on stimulus policies
First came the “new normal,” an era of subdued economic growth. It led to the “new neutral” scenario of lower central bank interest rates.
Now, the world is entering a phase of rising risks as the effect of central-bank stimulus policies diminishes, according to a long-term forecast by Pacific Investment Management Co.
“You can think of it as insecure stability,” Richard Clarida, Pimco’s global strategic adviser, said in an interview. “We believe there are diminishing returns to monetary-policy activism. They may still be positive, but they’re diminishing.”
Pimco’s outlook comes on the same day as the Organisation for Economic Cooperation and Development warned that the global economy is slipping into a self-fulfilling “low-growth trap” where ultra-loose monetary policy risks doing more harm than good. While global growth is just fast enough to keep economies from stalling, there are no evident sources of productivity increases or organic demand to support a more robust expansion, Pimco said.
Pimco published its three-to-five-year outlook Wednesday based on discussions and presentations at its annual secular forum in May in Newport Beach, California. The firm popularized the term new normal after a forum following the 2008 financial crisis to describe a protracted period of below-average economic growth, heightened government intervention and increasing clout for emerging-market economies. In 2014, it refined the outlook by arguing that central banks’ “neutral” policy rate had moved lower than it was before the crisis.
Financial markets have priced in the new neutral view, reflected in rising asset prices amid a search for yield, according to the report Clarida co-wrote with Pimco’s Andrew Balls and Daniel Ivascyn. The forum featured input from the firm’s global advisory board, which includes former Federal Reserve Chairman Ben Bernanke, ex-U.K. Prime Minister Gordon Brown and former European Central Bank President Jean-Claude Trichet.
With central banks in Europe and Japan pursuing negative-interest-rate policies and piling up debt with stimulative asset purchases, the impact of further monetary moves is limited, the authors wrote.
“There is the distinct possibility,” they said, “that monetary policy exhaustion and an overhang of debt in some major economies pose material threats to the sustainability of the global recovery and financial stability.”
The Paris-based OECD, which advises its 34 member countries, said that too much of the burden of lifting growth has been left to central banks. After pushing interest rates below zero and pumping money into their economies through asset purchases, they are starting to see diminishing returns and their actions could even generate financial-market volatility.
Pimco, which oversees $1.5 trillion, plans to “have more cautious positioning in our portfolios, and to make capital preservation the number-one priority,” according to the report.
The firm’s largest fixed-income mutual funds have a mixed record against the benchmark Barclays U.S. Aggregate Bond Index. In the past three years, the $87 billion Pimco Total Return Bond Fund has an annualized return of about 2.1 percent, compared with 4.5 percent for the $58 billion Pimco Income Fund and 3 percent for the index, according to data compiled by Bloomberg.
Pimco sees U.S. gross domestic product expanding at or slightly above an annual rate of 1.5 percent to 2 percent, compared with growth of 1 percent to 1.5 percent in the euro area and 5 percent to 6 percent in China.
“The game is only going on because of massive quantitative easing, negative zero interest rates and emerging economies,” Clarida said Wednesday during an interview on Bloomberg TV. “So our view is that investors cannot get a false sense of security by extrapolating past trends. So you see a world that now appears to be stable, but is not very secure.”
While most of the outlook warns of the risks of deflation and slowing economies, the firm also recommends buying inflation-protected securities, especially in the U.S., because they offer good value and valuable protection Other investing implications include seeking seniority in debt purchases, guarding against negative interest rates in Japan and Europe, and using active management to select securities that provide higher returns than an index.
“The broad theme is that we think there will be a reward for active management,” Clarida said in the interview. “This is not an environment where investors want to go passive.”