Pimco's Ivascyn: Next Inverted Yield Curve May Be DifferentBy
Recession signal’s power sapped by central-bank moves, he says
Top-ranked bond fund manager is bucking a Wall Street adage
Some see it as an almost surefire economic law: an inverted yield curve, when long-term bonds yield less than short-term debt, signals a coming recession.
That may not hold true in today’s world of unprecedented central-bank economic intervention, according to Dan Ivascyn, Pacific Investment Management Co.’s group chief investment officer.
“There’s a chance that this time around is very different,” said Ivascyn, who heads Pimco’s $1.51 trillion in investments. “We don’t think the predictive powers of the yield curve are what they would’ve been in a world of less central bank influence.”
After the 2008 financial crisis, bond buying by policy makers in Europe, Japan and, until recently, the U.S. pushed down interest rates to stimulate economic growth. As the Federal Reserve has gradually raised its benchmark target rate, yields on longer-term Treasuries have stayed suppressed because the securities still represent relative value for little risk.
“It could be the case that people are just reaching for yield because there’s too much global liquidity and the yield curve is really just a function of monetary policy outside the U.S. more than any type of predictor that there’s a recession,” Ivascyn said in a telephone interview from Pimco’s Newport Beach, California, headquarters.
On June 14, the Fed raised its target rate for the fourth time since December 2015, pushing up the front end of the curve. That day, 10-year Treasury yields fell to their lowest close since November, when Donald Trump’s presidential election victory sparked a bond selloff.
The target rate is expected to finish 2017 at about 1.375 percent and climb to almost 3 percent by the end of 2019, according to projections by the Federal Open Market Committee.
The gap between three-month and 10-year yields narrowed to 1.14 percentage points at Tuesday’s close. It dropped to 1.08 percent last July, the lowest since 2008.
Hedge funds and other large speculators this week kept plowing money into curve flatteners, or wagers that the yield spread between short- and long-term Treasuries will narrow. The trade has paid off handsomely, with the difference between five- and 30-year U.S. yields at the lowest since December 2007. The gap from 10 to 30 years shrunk for 11 straight days through Wednesday -- something that’s never happened in data going back to 1992.
Not everyone is as skeptical as Ivascyn. While central-bank policies will probably keep flattening the curve, an inversion is unlikely unless the U.S. economy heads into reverse, according to Jeffrey Rosenberg, chief fixed-income strategist at BlackRock Inc.
Rates on longer-dated debt were compressed during the financial crisis through quantitative-easing strategies that boosted the money supply. Now, the Fed’s plan to begin running off its $4.5 trillion balance sheet is a tool to push up rates for longer-dated maturities, he said.
“The unwinding should have the impact of a normalization of the term premium,” Rosenberg said in a telephone interview.
An inverted yield curve preceded the past seven U.S. recessions, as lower long-term rates signaled a weakening economic outlook. The curve inverted in mid-2006, about a year before the last recession began. There have also been “notable false positives,” including in late 1966, according to a report last month by the Cleveland Fed.
Still, betting that the laws of economics have changed can be risky. The 2009 book “This Time Is Different: Eight Centuries of Financial Folly,” by Carmen Reinhart and Kenneth Rogoff, concluded that when people say this time is different, “It almost never is.”
Ivascyn, 47, has been well served by his investing acumen during up and down markets. His $86 billion Pimco Income Fund averaged annual returns of 9.4 percent over the last 10 years, ranking in the top 1 percent of its peers, according to Morningstar Inc.
No matter what an inverted curve signals, there’s no reason to be complacent, according to a report last month by Pimco. The chances of a recession within five years are 70 percent, as the recovery underway since 2009 is likely to run out of steam, the firm said.
The Fed’s plans to raise rates and wind down its balance sheet amid low inflation may be the wrong medicine for the economy, according to Joachim Fels, a Pimco economic adviser.
“By hiking rates and starting balance-sheet runoff when inflation keeps undershooting, the Fed risks cementing inflation expectations firmly below target,” Fels wrote in a blog post Wednesday. “There is substantial risk that the Fed’s opportunistic tightening campaign is a hawkish mistake.”
Central bankers have few tools left after amassing huge balance sheets and driving rates into low and negative territory. Those policies may have spurred investors to accept lower long-term returns, according to Ivascyn.
“From a global investor perspective, they don’t care that they don’t earn much on the 10-year Treasury,” he said. “They just like it because they’re going to get their money back.”
— With assistance by Susanne Barton, and Brian Chappatta