The 10-year US yield is expected to generally move higher throughout the course of this year as yields are down at pretty close to the absolute low-end of the range, said Scott Mather, chief investment officer of US core strategies at PIMCO.
Domestic inflation expectations are likely to start rising as it has hit the low point in terms of energy prices. The impact of low oil prices on the US economy is going to diminish over time. PIMCO also expects to see wage pressures to rise. So putting all those things together, PIMCO expects to see the Fed to move and yields to rise generally this year.
Investors can expect to see many episodes of volatility in the marketplace; PIMCO’s key-message is that investors need to be very careful about mapping the equity market volatility with the real economy. The real economy is probably a lot more resilient than many realize, he noted.
Fed official Jim Bullard said recently the central bank will fail to meet its inflation target given the precipitous decline in oil prices. Looking at oil fundamentals, it’s hard to find a catalyst that could drive prices higher.
Asked how the Fed could justify a rate hike when inflation is nowhere close to their target rate, particularly if oil prices were to remain low for an extended period, Scott said very low expectations are already priced into the energy curve. The markets have basically priced in low prices that last forever though PIMCO thinks current prices are too low.
What’s unique about the current environment for the last year or so is much of the decline in prices has been led by an increase in supply; it’s not as if demand has fallen off the cliff.
People are sort of sometimes reading this drop in commodity prices as if it’s all demand related; that has been the case in prior episodes, but not in the present one. As long as demand keeps growing continuously this year – as PIMCO expects – and supply continues to diminish, as being witnessed in the US, investors can expect prices to go back up. But in the meantime, investors should bear in mind the current drop in energy prices has been tremendously beneficial for the US consumer and in general is good for the US economy, he explained.
While people are concerned about the decline in oil prices and the general drop in commodities, they are also concerned about slowing China and world growth. Asked if he shares those concerns, Scott said while it’s okay to be concerned about growth, PIMCO is more concerned about the potential for a misstep in terms of currency policy or other domestic policy in China that really creates a bigger underlying problem.
But in the absence of that, PIMCO thinks investors can’t just look at low commodity prices and assume that means the economy is heading for something similar to 2008 or a big downturn in the global cycle. PIMCO thinks most of the low prices are due to additional supply.
While its true demand has not been growing from China the same pace it was many years ago, in general that’s a good thing for the world’s developed economies because that means growth will be higher than it would have been otherwise. So PIMCO wants to stay focused on that and take advantage of some of these volatile periods in the market dislocations that result in picking up new investments and sectors that are priced too cheaply, he observed.
Some people are calling the current period a re-calibration where the market is just trying to regain its balance with the Fed now raising rates after all those years of lowering them and keeping them low for such a long period of time.
Asked if he’s surprised by the current volatility and if higher volatility could give the Fed some pause before they hiked again, Scott answered in negative. PIMCO has been expecting volatility for some time and had positioned itself accordingly.
PIMCO expects elevated volatility to continue on throughout the course of 2016 and expects to see a lot more time frames when the VIX (volatility index) is up in the high teens or low twenties versus where it was in the last several years.
But that should be expected, because of the turn of the US monetary policy cycle and the diverging policies between the US and the rest of the world. So more of the current volatility would continue; but people would make a mistake if they map the current volatility directly on the real economy and assume volatility to have the same impact it would have had three or four years ago when the economy was much weaker, he concluded.
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