Blog

Cyclical Outlook Takeaways: Bounded Optimism on the Global Economy

Global output and demand are likely to rebound strongly in 2021, but we see risks that call for careful portfolio positioning.

The global economy is likely to make good progress along the path to recovery over the cyclical horizon, especially in the second half of 2021. However, much of this growth is already priced in to markets. Investors should also beware of several macro risks that command careful portfolio construction to weather renewed bouts of volatility in financial markets.

In our January 2021 Cyclical Outlook we discuss the outlook for global growth, policy, and inflation in 2021, together with the implications for markets and investors. This blog post is a distillation of our views.

Baseline outlook: growth rebound, elusive inflation

Following an outsized contraction of economic activity in 2020, global output and demand are likely to rebound strongly this year. We expect the current renewed weakness due to lockdowns in major economies to give way to accelerating gross domestic product (GDP) growth from around the second quarter, driven by the broadening rollout of vaccines and continued fiscal and monetary policy support. Coming off a low base, world GDP growth in 2021 is expected to be the highest in more than a decade.

Consumer price inflation is likely to creep up only moderately during this year and generally remain below central banks’ targets in all major economies.

Monetary and fiscal policy support growth

Central banks will likely keep borrowing costs low in order to enable ongoing fiscal support for years to come. Policy rates are likely to remain at present levels in the foreseeable future or could even be reduced further in some countries. Asset purchases are likely to continue throughout, and likely well beyond, 2021.

Fiscal policy remains a key swing factor in our cyclical outlook. Most governments are likely to keep propping up household incomes via transfers and supporting companies via loan guarantees, subsidies, and tax breaks.

Three key risks to the baseline outlook

An onset of fiscal fatigue (in which governments return to a more cautious stance) would be a significant risk to the expected economic recovery, particularly in the second half of this year and more so in 2022.

Also, with China exhibiting strong growth momentum coming into 2021, we expect policymakers to refocus on deleveraging in the course of this year. We see a risk of overtightening, which could cause a sharper-than-expected growth slowdown.

The greatest uncertainty in the economic outlook stems from potential scarring effects that could inhibit or even prevent a swift return to pre-pandemic levels of consumer spending as well as corporate investment and hiring decisions.

Investment implications

We see both upside and downside risks to government bond yields in the near term, reflecting the push and pull between lockdowns and reduced activity and vaccine rollout. In most of our portfolios, we anticipate being fairly neutral on overall duration. We may employ curve-steepening positions in our core bond portfolios, given our view that while central banks will anchor front ends, over time markets will likely price greater reflation into the longer ends of curves.

Though we see little inflation upside risk over the cyclical horizon, we continue to see U.S. Treasury Inflation-Protected Securities (TIPS) offering a reasonably priced hedge against higher inflation in the U.S. over the longer term.

We expect to favor agency and non-agency mortgages and other structured product positions, carefully selected corporate credit overweights, and hard-currency-denominated emerging market sovereign credit exposures. We will be careful to avoid generic tight corporate credit positions, preferring to rely on the active picks of our credit teams. On currencies, we expect to maintain a modest U.S. dollar underweight.

While risk markets can continue to perform well over the coming months in response to broadening vaccine rollout and policy stimulus, investors may have become too complacent in light of the risks. We see this as a time for careful portfolio positioning and not for excessive optimism or risk-taking. Given the overall low level of yields, tight spreads, and low volatility, we plan to place significant emphasis on capital preservation and careful liquidity management.

Once the easy pandemic recovery trades have played themselves out, we expect a difficult market environment. As active managers, we will look to add value with security selection across credit sectors, with a focus on high quality sources of income, and seek to find the best global opportunities.

For more details on our outlook for the global economy in 2021 and the investment implications, please read the full Cyclical Outlook,Bounded Optimism on the Global Economy.”

Joachim Fels is PIMCO’s Global Economic Advisor and Andrew Balls is CIO Global Fixed Income.

The Author

Joachim Fels

Global Economic Advisor

Andrew Balls

CIO Global Fixed Income

Related

Disclosures

London
PIMCO Europe Ltd
11 Baker Street
London W1U 3AH, England
+44 (0) 20 3640 1000

Dublin
PIMCO Europe GmbH Irish Branch,
PIMCO Global Advisors (Ireland)
Limited
3rd Floor, Harcourt Building 57B Harcourt Street
Dublin D02 F721, Ireland
+353 (0) 1592 2000

Munich
PIMCO Europe GmbH
Seidlstraße 24-24a
80335 Munich, Germany
+49 (0) 89 26209 6000

Milan
PIMCO Europe GmbH - Italy
Corso Matteotti 8
20121 Milan, Italy
+39 02 9475 5400

Zurich
PIMCO (Schweiz) GmbH
Brandschenkestrasse 41
8002 Zurich, Switzerland
Tel: + 41 44 512 49 10

PIMCO Europe Ltd (Company No. 2604517) is authorised and regulated by the Financial Conduct Authority (12 Endeavour Square, London E20 1JN) in the UK. The services provided by PIMCO Europe Ltd are not available to retail investors, who should not rely on this communication but contact their financial adviser. PIMCO Europe GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Europe GmbH Italian Branch (Company No. 10005170963), PIMCO Europe GmbH Irish Branch (Company No. 909462), PIMCO Europe GmbH UK Branch (Company No. BR022803) and PIMCO Europe GmbH Spanish Branch (N.I.F. W2765338E) are authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 32 of the German Banking Act (KWG). The Italian Branch, Irish Branch, UK Branch and Spanish Branch are additionally supervised by: (1) Italian Branch: the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act; (2) Irish Branch: the Central Bank of Ireland in accordance with Regulation 43 of the European Union (Markets in Financial Instruments) Regulations 2017, as amended; (3) UK Branch: the Financial Conduct Authority; and (4) Spanish Branch: the Comisión Nacional del Mercado de Valores (CNMV) in accordance with obligations stipulated in articles 168 and 203 to 224, as well as obligations contained in Tile V, Section I of the Law on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217/2008, respectively. The services provided by PIMCO Europe GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication.| PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2) . The services provided by PIMCO (Schweiz) GmbH are not available to retail investors, who should not rely on this communication but contact their financial adviser.

All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Inflation-linked bonds (ILBs) issued by a government are fixed income securities whose principal value is periodically adjusted according to the rate of inflation; ILBs decline in value when real interest rates rise. Treasury Inflation-Protected Securities (TIPS) are ILBs issued by the U.S. government. Mortgage- and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and while generally supported by a government, government-agency or private guarantor, there is no assurance that the guarantor will meet its obligations. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Currency rates may fluctuate significantly over short periods of time and may reduce the returns of a portfolio.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision. Outlook and strategies are subject to change without notice.

Assessing Inflation: Theories, Policies and Portfolios
XDismiss Next Article