By Daniel J. Ivascyn, Esteban Burbano
We see compelling value in high quality, liquid fixed income assets that may offer potential resiliency if the economy weakens.
With proper positioning, today’s bond market may offer the potential for equity-like returns with less risk. Here, Dan Ivascyn, who manages the PIMCO Income Strategy with Alfred Murata and Josh Anderson, talks with Esteban Burbano, fixed income strategist. They discuss how the strategy is positioned to seek higher yields and the potential for price appreciation that fixed income is now offering, while striving to remain resilient in the face of economic uncertainty.
Q: Recent inflation reports suggest the Fed may be near the end of its rate-hiking cycle, yet the economy has considerable momentum, particularly the labour markets. What is your outlook and how does that impact portfolio positioning?
Ivascyn: Our base case projections anticipate core inflation will trend lower but linger above central bank targets for several quarters in the U.S., Europe, and some other developed economies. This path to central bank targets may also be bumpy and could include a slight reacceleration in core inflation over the next few months. Monetary policy takes time to filter through the economy, though, raising the risk of a recession when the full impact of the sharpest tightening cycle in decades is felt. We think the risk of at least a mild recession before central banks get inflation back near target levels may be greater than half.
With that in mind, we’ve increased credit quality in the Income portfolios, while seeking ample liquidity to pursue resilience and flexibility in the face of an uncertain economic trajectory. These high quality assets can provide compelling yields, with potential downside resilience and price appreciation should we slide into a recession. Our flexibility has already enabled us to take advantage of market dislocations in high quality assets that have been caused by fear or sudden shifts in economic expectations. We expect volatility across the globe to continue into 2024, providing fertile ground for active managers.
Q: The key risks in a fixed income strategy are that interest rates rise or credit deteriorates, both of which would cause bond prices to decline. Looking at interest rate risk, or duration, how are you positioning the Income Strategy along the yield curve and across different countries?
Ivascyn: As shorter-term yields have risen, we’ve increased our interest rate exposure, particularly in the front and intermediate portion of the curve. The inverted yield curve, where short-term rates are higher than long-term rates, enables us to seek attractive income without taking significant interest rate risk further out the curve.
If yields were to rise meaningfully from here, we may increase our interest rate exposure across our portfolios further. One of the many advantages we have over passive alternatives is the ability to tactically manage interest rate exposure, as we did in 2022, and that helped protect capital.
Our interest rate exposure is focused primarily in the United States, where rates are higher than other developed countries, though we have very modest positions in emerging markets, and we have a small underweight to Japanese interest rates. Localized volatility in interest rate markets has given us opportunities to trade our exposure more actively along the yield curve.
Daniel J. Ivascyn