Cyclical Economic Outlook Seven Macro Themes for 2020 · Market size, market value, and OAS based...

Seven Macro Themes for 2020

January 2020

Cyclical Economic Outlook

For professional and educational use only

1

Important information

For professional use only and for educational use only

The services and products described in this communication are only available to professional clients as defined in the Financial Conduct Authority's Handbook. This

communication is not a public offer and individual investors should not rely on this document. Opinion and estimates offered constitute our judgment and are subject to

change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable,

but do not warrant its accuracy or completeness.

PIMCO Europe Ltd (Company No. 2604517) and PIMCO Europe Ltd - Italy (Company No. 07533910969) are authorised and regulated by the Financial Conduct

Authority (12 Endeavour Square, London E20 1JN) in the UK. The Italy branch is additionally regulated by the Commissione Nazionale per le Società e la Borsa

(CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act. PIMCO Europe Ltd services are available only to professional clients as defined in the

Financial Conduct Authority’s Handbook and are not available to individual investors, who should not rely on this communication. | PIMCO Deutschland GmbH

(Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Deutschland GmbH Italian Branch (Company No. 10005170963), and PIMCO Deutschland

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 and Spanish Branch are additionally supervised by

the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act and 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 Deutschland 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), Brandschenkestrasse 41, 8002 Zurich, Switzerland, Tel:

+ 41 44 512 49 10. The services provided by PIMCO (Schweiz) GmbH are not available to individual investors, who should not rely on this communication but contact

their financial adviser.

(Presented in Ireland)

2

Biographical information

Joachim Fels

Mr. Fels is a managing director and global economic advisor based in the Newport Beach office. He is a member of the Investment Committee and leads PIMCO's

quarterly Cyclical as well as the Secular Forum process. Prior to joining PIMCO in 2015, he was global chief economist at Morgan Stanley in London. Previously he was

an international economist at Goldman Sachs and a research associate at the Kiel Institute for the World Economy. He has 32 years of macro research experience and

holds a diploma in international studies from the Johns Hopkins University School of Advanced International Studies in Bologna, Italy; a master's degree in economics

from Universität des Saarlandes in Saarbrücken, Germany; and an undergraduate degree from Christian-Albrechts-Universität in Kiel, Germany.

Nicola Mai

Mr. Mai is an executive vice president in the London office and a sovereign credit analyst in the portfolio management group. He leads sovereign credit research in

Europe, and is a member of the European portfolio committee. He is responsible for formulating key macro views for the region and for identifying and analyzing

global macro and investment trends. Prior to joining PIMCO in 2012, Mr. Mai was senior euro area economist at J.P. Morgan for seven years. He started his career as an

economist in the U.K. government, in a program run by HM Treasury. He has 17 years of investment and financial services experience and holds a graduate degree in

economics from Universitat Pompeu Fabra in Barcelona and an undergraduate degree in economics from the London School of Economics.

3


Source: PIMCO

1) “Time to recession” has increased

2) “Loss given recession” has increased

$ 3) Potential cracks in corporate credit cycle

4) U.S. housing strength

5) The world leads, the U.S. lags

6) Inflation: The devil they prefer

7) Dealing with disruption

4

1) Time to recession has increased

For illustrative purposes only. Source: Haver Analytics, PIMCO calculations as of 1 November 2019. Left chart: World includes approximately 240 countries. Data is interpolated where unavailable. Note: The PIMCO World Financial Conditions Index (FCI) is a proprietary index that summarizes the likely impact on growth from a range of financial variables, including bond yields, equity prices, currency rates, house prices and money supply. In this inverted depiction, an increase in the FCI indicates an easing of financial conditions. Right chart:: Recession probability models are only 1 input into PIMCO's overall assessment of recession risk Refer to Appendix for additional forecast, outlook and risk information.

-2%

-1%

0%

1%

2%

3%

4%-4%

-2%

0%

2%

4%

6%

Jan '80 Jan '90 Jan '00 Jan '10 Jan '20

World GDP Growth and Financial Conditions

World Real GDP Growth (y/y, LHS)

World Financial Conditions Index (RHS, inverted)

Central bank actions helped ease global financial conditions… …and reduce the risk of recession in the near term

Ea

sin

g

Tig

hte

nin

g

0%

25%

50%

75%

100%

Jan '62 Jan '70 Jan '78 Jan '86 Jan '94 Jan '02 Jan '10 Jan '18

U.S. Probit Recession Model (12m)

Recession CombinedPIMCO recession model (PROBIT)

5

U.S. 10yr Yields

lowest

0 25 50 75 100

Percentile

Volatility (VIX)

HY Spreads

S&P 500 P/E Ratio (CAPE)*

highest

tightest

lowest

widest

Top Quartile

highest

lowesthighest

Investment implication: More constructive, but starting points matter

As of 31 December 2019.

Source: Bloomberg

High Yield (HY) spreads are represented by the Bloomberg Barclays US Corporate High Yield Avg OAS index.

Refer to Appendix for additional index, investment strategy, outlook and risk information.

Rank relative to past 20 years

Highlights

• Positive carry from more

diversified sources, biased

toward higher-quality

• Overall duration closer to flat

• Less generic corporate credit

exposure given valuations

• Modest overweight to equities

Current (31 Dec ‘19) 1 year ago (31 Dec ‘18)

6

2) Loss given recession has risen

Source: Haver, PIMCO, as of 31 December 2019.

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000


US

D B

ill

Developed Market Central Bank Balance Sheets

Fed ECB BoJ BoE

Central banks have exhausted more of their toolkit, leaving less policy space for future action

-1

0

1

2

3

4

5

6

7

'01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17 '18 '19

Po

licy

rate

(%

)

Fed ECB BoE BoJ

Developed Market Central Bank Policy Rates

7

2.68

0.00 0.24

1.28

1.92

(0.01)

(0.19)

0.82

(1.0)

(0.5)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

US 10 Year Tsy 10 Year JGB 10 Year Bund 10 Year Gilt

Yie

ld (

%)

Dec'18 yield Dec '19 yield

Investment implication: Favor U.S. duration, with less generic risk beta

As of 31 December 2019

SOURCE: PIMCO, Bloomberg.

Refer to Appendix for additional investment strategy, outlook and risk information

Comparison of current global yields to their respective lowest historic levels

U.S. rate exposure more

compelling given higher yield

levels and more room to fall

Highlights

• Favor US duration over global

alternatives given relative

value and more potential for

capital gains

• Long Japanese yen positions

given risk-off exposure (and as

proxy for duration)

• Cautious stance on generic

credit risk

8

3) Cracks in the corporate credit cycle

Source: Haver Analytics, U.S. Federal Reserve, PIMCO calculations as of 30 September 2019. Left chart: shows the close correlation between GDP and the ebb and flow of overall credit to the corporate sector. The debt impulse is the dollar change in overall corporate debt flows, including bank loans, corporate bond issuance and private credit from the Federal Reserve’s flow of funds data. Right chart: other loans and advances is a proxy for private financing.

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

Dec '63 Dec '69 Dec '75 Dec '81 Dec '87 Dec '93 Dec '99 Dec '05 Dec '11 Dec '17

GD

P

Recession

Other Loans and Advances

U.S. Domestic Private Debt

-1

-0.8

-0.6

-0.4

-0.2

0

0.2

0.4

0.6

-4

-2

0

2

4

6

8

Dec '05 Dec '10 Dec '15

USD Trillions %

U.S. Nominal GDP

U.S. Corporate Debt Impulse (RHS)

U.S. Non-Financial Business Sector Debt Impulse

Riskier segments of the credit market may be more vulnerable to pronounced growth slowdowns

$

9

Investment implication: Cautious on generic corporate credit

As of 31 December 2019. Leverage as of most recently available. Source: PIMCO, Bloomberg, Barclays

Market size, market value, and OAS based on Bloomberg Barclays U.S. Credit Index. Leverage based on IG CDX 32

Refer to Appendix for additional index, investment strategy, OAS, outlook, and risk information.

1.8x

2.7x

.x

.5x

1.x

1.5x

2.x

2.5x

3.x

Dec-2008 Sep-2019

Ne

t L

eve

rag

e

204

90

0

50

100

150

200

250

Jan-2008 Dec-2019

Op

tio

n A

dju

ste

d S

pre

ad

(b

ps

)

31%

47%

0%

10%

20%

30%

40%

50%

60%

Dec-2008 Dec-2019

Pct. o

f U

.S.

Ag

g C

red

it (%

ma

rke

t va

lue

)

2.5

6.9

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

Dec-2008 Dec-2019

Ma

rke

t S

ize

($

T)

GROWING MARKET

The investment grade credit

market has more than

doubled since 2008

INCREASED CREDIT RISK

The share of BBBs in the U.S.

Credit market has increased

16% since 2008. BBBs now

make up twice the size of the

high yield market vs. 1x in 2008

HIGHER LEVERAGE

Companies are taking on more

debt and leverage in the

investment grade credit market

has increased 0.9x

REDUCED COMPENSATION

FOR RISK

Companies can borrow at lower

rates as credit spreads have

come down over 100 basis points

since the start of 2008

$

10

4) Home, sweet home

Source: Haver Analytics, Bloomberg, PIMCO calculations as of 30 September 2019. Left chart: Cumulative excess homes built is the cumulative difference between housing starts and household formations. Right chart: The PIMCO Affordability ratio is a seasonally adjusted measure of the affordability of a median priced home, based on median income and prevailing mortgage rates.

60

62

64

66

68

70

-1

0

1

2

3

2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020

Pe

rce

nt M

illio

ns

Cumulative Excess Homes Built (LHS)

Homeownership rate (RHS)

Cumulative Excess U.S. Homes Built & Homeownership Rate

100

125

150

175

200

Jan '04 Jan '09 Jan '14 Jan '19

PIMCO U.S. Affordability Ratio

U.S. Housing supply has fallen while demand remains robust U.S. Housing affordability measures appear favorable

More affordable

11

-110

-100

-90

-80

-70

-60

-50

-40

-30

-20

-10

0

10

20

30

40

50

60

70

80

90

100

'09 '10 '11 '12 '13 '14 '15 '16 '17 '18 '19

Model R

ich/C

heap v

s S

waps (

in b

ps)

Agency MBS Spread Valuation

3% Rich/Cheap 3.5% Rich/Cheap 4.0% Rich/Cheap

Investment implication: Preference for housing-related assets


SOURCE: PIMCO

Rich/Cheap valuations are intended to represent the relative level of Agency MBS spread valuations. This represents our empirical spread which relies on a combination of rates, shape of the curve, interest rate volatility, and the refinanceability of the mortgage market.


Ric

h

Ch

eap

Highlights

• Favor Agency MBS given

compelling valuations,

reasonable carry, and

attractive liquidity profile

• Non-Agency MBS attractive

as a more defensive source

of credit and carry

• Select opportunities in other

securitized (CMBS, U.K.

residential assets)

12


Source: Haver, PIMCO. Left chart as of 30 September 2019. Right chart as of 30 November 2019. DM: Developed Markets. EM: Emerging Markets.

49

50

51

52

53

54

55

56

Jan '16 Jan '17 Jan '18 Jan '19

Composite PMI

DM EM

-5%

-4%

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

'08 '09 '10 '11 '12 '13 '14 '15 '16 '17 '18 '19

Re

al G

DP

(Y

oY

%)

US Advanced Economies ex-US

Real GDP

U.S. growth momentum slowed later – and less – than the

rest of the world Signs of a rebound have already begun to emerge

13

Investment implication: Seek opportunities in select currencies


SOURCE: Bloomberg, PIMCO


100

105

110

115

120

125

130

135

Dec '14 Jun '15 Dec '15 Jun '16 Dec '16 Jun '17 Dec '17 Jun '18 Dec '18 Jun '19

Ind

ex

leve

l

Trade-weighted U.S. Dollar

US dollar (trade-weighted)

US

D a

pp

recia

tin

g

Highlights

• Expect an overweight to a

basket of EM currencies

against the US dollar

• Seek opportunities in G10

currencies against the

U.S. dollar if more evident

divergence in growth

momentum

• Favor US duration over other

regions

14


Source: Haver, PIMCO calculations, as of 30 September 2019.

The Organisation for Economic Co-operation and Development is an intergovernmental economic organisation with 36 member countries, founded in 1961 to stimulate economic progress and world trade. The personal consumption expenditures (PCE), or the PCE Index, measures price changes in consumer goods and services. Expenditures included in the index are actual U.S. household expenditures. Data that pertains to services, durables and non-durables are measured by the index.

5

6

7

8

9

Jan '98 Jan '03 Jan '08 Jan '13 Jan '18

OE

CD

un

em

plo

ym

en

t ra

te (

%)

OECD Unemployment Rate

60

70

80

90

100

110

120

Mar '91 Mar '95 Mar '99 Mar '03 Mar '07 Mar '11 Mar '15 Mar '19

PC

E p

rice

le

ve

l

PCE Price Level

PCE Price Deflator (SA, 2012=100)

Price Level Path Consistent with 2% Inflation

Fed announces 2%

inflation target

Wage pressures from tight labor markets could cause an

inflation surprise

Given extent of undershooting, U.S. Fed may allow inflation

to overshoot

15

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Dec '09 Dec '11 Dec '13 Dec '15 Dec '17 Dec '19

Spre

ad b

etw

een 5

and 3

0yr

yie

lds

Change in shape of U.S. yield curve between 5- and 30yr

5s30s spread

1.0

1.5

2.0

2.5

3.0

3.5

4.0

'06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17 '18 '19

Bre

akeven inflation (

%)

U.S. Inflation expectations in markets appear low

U.S. 5y5y forward breakeven

2006- June 2014 average (pre-oil market decline)

Fed inflation target (2.0% PCE + 0.35% CPI wedge)

Investment implication: Bias for curve steepeners and inflation protection


SOURCE: Bloomberg, PIMCO.


Ste

ep

en

ing

Highlights

• Favor curve steepening

positions given

– Front-ends anchored by

central banks

– Potential for higher U.S.

inflation expectations

– Potential return of term

premia

• TIPS valuations attractive

given balance of risks skew

toward higher U.S. inflation

16

0

200

400

600

800

1000

1200

1400

1600

1800

2000

'89 '91 '93 '95 '97 '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19

Ind

ex

leve

l

Trade Policy Uncertainty Index

NAFTA

Trade War Escalation

Trump

Tarrifs

7) Dealing with Disruption in trade policy

Source: Bloomberg, The Green Papers, as of December 31, 2019.

17

7) Dealing with Disruption in politics

Source: Bloomberg, The Green Papers, as of December 31, 2019.

Date % of total delegates

Cumulative % of total delegates

Mar 3: Super Tuesday

37% 41%

Mar 10 13% 56%

Mar 17 13% 69%

Apr 28 15% 87%

June 2-16 6% 100%

We could see a winnowing of the race by early March

The earliest we could see a candidate secure a

majority of delegates

If no candidate has a simple majority of delegates by

June, we could see a brokered convention in July

New York and Pennsylvania could be important

A (possibly) long Democratic primary due to a crowded race, proportional allocation of delegates + less party power

18 EM_stru_06

Recent Protests in EM

7) Dealing with Disruption from unrest in emerging markets

Protests increasingly frequent, geographically dispersed and with varied drivers

As of 28 November 2019. SOURCE: PIMCO

Indonesia

Zimbabwe

Sudan

Ethiopia

Algeria

Georgia

Romania

Albania

Montenegro

Nicaragua

Honduras

Venezuela

Colombia

Ecuador

Argentina

Peru Bolivia

Lebanon

Chile

Hong Kong

India

Iraq

Iran

19

PIMCO’s 2020 Cyclical Outlook

For illustrative purposes only.

PIMCO forecast ranges as of December 2019

Real GDP and inflation projections reflect the midpoints of PIMCO’s forecast ranges.

Refer to Appendix for additional forecast, outlook and risk information.

Brazil

GDP: 1.00%–2.00%

CPI: 3.50%–4.50%

Mexico

GDP: 0.50%–1.50%

CPI: 3.50%–4.50%

Eurozone

GDP: 0.75%–1.25%

HICP: 0.75%–1.25%

U.K.

GDP: 0.75%–1.25%

CPI: 1.25%–1.75%

China

GDP: 5.00%–6.00%

CPI: 3.00%–4.00%

U.S.

GDP: 1.50%–2.00%

CPI: 1.75%–2.25% Japan

GDP: 0.25%–0.75%

CPI: 0..25%–0.75%

Change

relative to

2019 data

% of

world

GDP

3cs_intl_outlook_01

=

20


Source: PIMCO

1) “Time to recession” has increased

2) “Loss given recession” has increased

$ 3) Potential cracks in corporate credit cycle

4) U.S. housing strength



7) Dealing with disruption

European Cyclical Outlook

January 2020

For professional and educational use only

22

Most open economies were hit the hardest during the trade-driven

slowdown

Source: PIMCO, IMF, various statistics offices.

China

Japan

United Kingdom

United States

Eurozone

BRIM

East Asia

Germany

y = -0.08x - 0.43 R² = 0.74

-1.4

-1.2

-1.0

-0.8

-0.6

-0.4

-0.2

0.0

-4.0 -2.0 0.0 2.0 4.0 6.0 8.0

Current account balance (% GDP, X-axis) vs GDP slowdown (%yoy diff Q219-Q417, normalized, Y-axis)

0

10

20

30

40

50

60

70

90 95 00 05 10 15

Trade openness (exports and imports as % GDP)

China Japan United States Eurozone (extra-Eurozone trade only)

23

Eurozone exports slowed sharply and have room to rebound

Source: PIMCO, Eurostat.

-1.4

-1.2

-1.0

-0.8

-0.6

-0.4

-0.2

0.0

Euro area exports, 10 largest export markets Contribution to deceleration in extra-EA export growth from Jan 2018

to Jun 2019 (%y/y, 3mma)

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

15 16 17 18 19

Extra-EA exports volume: contributions (%y/y, 3mma)

US Rest of the world UK China Total extra-EA exports

24

Financial / credit conditions remain supportive

Source: PIMCO, Bloomberg, Markit, various central bank and statistics offices.

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

02 04 06 08 10 12 14 16 18 20

Financial Conditions: Eurozone Up = easing; down = tightening

-8

-6

-4

-2

0

2

4

6

-10

-5

0

5

10

15

02 04 06 08 10 12 14 16 18 20

Real M1 (%3m/3m saar, 3mma, +3Q, LHS) Real GDP Growth (QoQ saar, RHS)

Real M1 growth (advanced 3q) vs. GDP growth

25

Fiscal policy also a modest boost

As of December 2019.

SOURCE: PIMCO, European Commission.

-0.44-0.35

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Euro area fiscal consolidationGovt medium-term austerity plans , % GDPti

ghte

nin

g

easing

26

Large fiscal package not the base case though

Source: PIMCO, various pollsters. Note: Solid line is a 10-poll moving average.

0

5

10

15

20

25

30

35

40

45

17 18 19 20

Union (27%)

SPD (13%)

AfD (14%)

Grune (22%)

German political opinion polls (%)

27

Scope for pent up demand to be released in the Eurozone

Source: PIMCO, various statistics offices.

90

95

100

105

110

115

120

125

130

08 09 10 11 12 13 14 15 16 17 18 19 20

US UK Euro area

+24.7%

+14.1%

+5.5%

Real consumer spending + fixed investment (Index, Q1 08 = 100)

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

08 09 10 11 12 13 14 15 16 17 18 19 20

US UK Eurozone

Unemployment difference from Dec-07

28

Auto sector remains a headwind

Source: PIMCO, various statistics offices.

90

95

100

105

110

115

120

15 16 17 18 19 20

Eurozone: Manufacturing (Index, 2015 = 100)

Mnfg. Autos Mnfg. ex autos

-3.5

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

Jun-1

8

Jul-1

8

Aug-1

8

Sep-1

8

Oct-

18

No

v-1

8

De

c-1

8

Jan-1

9

Feb

-19

Ma

r-1

9

Apr-

19

Ma

y-1

9

Jun-1

9

Jul-1

9

Aug-1

9

Sep-1

9

Oct-

19

No

v-1

9

Autos Mnfg ex autos Mnfg

Cumulative decline (%) in manufacturing: Contribution

29

Weakness “hangover” weighing on the labour market

Source: PIMCO, Markit, Eurostat.

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

33

38

43

48

53

58

63

00 02 04 06 08 10 12 14 16 18 20

Employment (PMI vs. growth)

Composite PMI Employment (LHS) Employment (QoQ saar, RHS)

30

Volatile politics still a headwind

Source: PIMCO.

US-China “fragile truce”

US-EU trade disputes still a risk (auto tariffs not yet off the table)

Italian politics remains volatile

More Brexit drop-dead dates this year

?

?

Key political considerations for 2020

?

?

31

On balance, recession risks have fallen

Source: PIMCO, various statistics offices, Bloomberg.

Lower sovereign and corporate spreads have eased financial conditions , and lowered the recession probability in our models.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

02 04 06 08 10 12 14 16 18 20

Recession Probability: Eurozone

Combined Model Financial Model Economic Model Recession Probability

32

Tentative signs of a turn in activity

As of January 2020.

SOURCE: PIMCO, Eurostat, Markit, Haver.

46

48

50

52

54

56

58

60

62


Eurozone PMI

Services Manufacturing (Output) Composite (Output)

33

We expect a gradual reacceleration ahead , led by Germany


SOURCE: PIMCO, Eurostat, Markit, Haver.

-5

-4

-3

-2

-1

0

1

2

3

4

5

11 12 13 14 15 16 17 18 19 20 21

Real GDP (%q/q, saar) -- PIMCO forecast

Germany France Italy Spain

34

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

Mar '02 Mar '04 Mar '06 Mar '08 Mar '10 Mar '12 Mar '14 Mar '16 Mar '18

Collective wage bargaining (% yoy)

Euro area France Germany Italy Spain

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

Jan'07

Jan'08

Jan'09

Jan'10

Jan'11

Jan'12

Jan'13

Jan'14

Jan'15

Jan'16

Jan'17

Jan'18

Jan'19

Eurozone inflation, %yoy

HICP Core HICP

Inflation to remain well below target through 2020

• Inflation looks set to remain low. We see some pass-through of recent wage increases into core services inflation. But the

rise is likely to be muted, as wage inflation is likely to flat-line in an environment of weaker growth.


SOURCE: PIMCO, Haver, Eurostat.

35

Actions from September Meeting

10bps rate cut to -0.5%, rates low until ECB sees

meaningful uptick in inflation

Strengthen forward guidance on rates & reconfirm

forward guidance on reinvestments

Restarting asset purchase program (APP) at €20bn until

further notice

TLTRO borrowing costs are cut, operation extended

from two to three years

Tiering on excess deposits for banks

✓

✓

✓

✓

Source: PIMCO, Bloomberg

3cs_EUR_outlook_03

ECB on autopilot: Negative policy rates and QE infinity

✓

“The answer is fiscal policy.”

• ECB signaling to fiscal policymakers that interest

rate policy has reached its limits, but asset

purchases will be there to support fiscal policy for

as long as necessary.

• The ECB has, like the BoJ, handed over the

baton to elected government officials

Expect the ECB to keep rates unchanged

over the cyclical horizon

• Given proximity to effective lower bound and

greater focus on fiscal policies we expect the

ECB’s focus from here to remain on forward

guidance, TLTROs and asset purchases

36

Where do yields go from here?

Base case

• PIMCO’s expectation is that risk free yields will remain at or close to current levels for the foreseeable future

Rates Moving Lower

• Negative rate policy does not have much further room to

run given risk of:

o Impairment to banking system

o Challenges for other parts of financial system

(insurance companies, pension schemes)

o Negative nominal rates encouraging more, not less,

savings

Rates Moving Higher

• ECB unlikely to increase policy rate in the foreseeable

future;

o Outlook for both growth and inflation remain

subdued

o Efficacy of policy in question

o Signalling increase would have an adverse effect on

Euro

• Inflation surprise to upside may move rates higher

o Would require a shift in fiscal policy in Germany,

likely as a result of government change

• A lift in global interest rates (e.g. action by the US Fed)

could have contagion effects for sovereign yields in the

Eurozone

37

UK: Volatile but slowing GDP growth

As of January 2020

SOURCE: PIMCO, Markit

70

75

80

85

90

95

100

105

110

115

120

Jan '07 Jan '09 Jan '11 Jan '13 Jan '15 Jan '17 Jan '19

Business investment (index, 2007 =100)

Brexit referendum

• GDP growth has been choppy, largely because of Brexit-related factors. Through the noise, underlying growth has slowed to

below trend.

• We expect a modest and gradual recovery through 2020, as global trade improves and fiscal easing feeds through in the

second half of the year. Against that, uncertainty about the precise future trading arrangement between the EU and UK will

likely continue to weigh on business investment and sentiment.

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

Jan'07

Jan'08

Jan'09

Jan'10

Jan'11

Jan'12

Jan'13

Jan'14

Jan'15

Jan'16

Jan'17

Jan'18

Jan'19

Jan'20

UK: Growth tracking

GDP (%3m/3m, saar) GDP tracker (using business surveys)

38

1.5

2.5

3.5

4.5

5.5

6.5

7.5

8.5

0.0

1.0

2.0

3.0

4.0

5.0

6.0


Private earnings (%YoY, 3mma, LHS)

Unemployment rate (%, RHS, inverted, advanced +6m)

Wage Phillips Curve

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0


Headline CPI Core CPI

UK: Inflation (%yoy)

UK: Inflation to remain subdued

As of December 2019

SOURCE: ONS, PIMCO

Income_UK_outlook_Amey_05

• Inflation looks set to be below the Bank of England’s 2% target in 2020, in part because of scheduled cuts in regulated electricity and

energy prices.

• Wage growth remains relatively high, but we do not expect it to meaningfully feed into higher consumer prices

39

UK: We expect the BoE to remain on hold, with risk tilted towards a cut in the

first half of the year


SOURCE: London International Financial Futures & Options Exchange (LIFFE)

Refer to Appendix for additional outlook information.


• We expect the BoE to be on hold in the near term, conditional on a modest pickup in domestic activity in the coming months. If activity

fails to pick up, we expect the BoE to cut its policy rate in the first half of the year.

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

%

UK short term interest rate expectations

1/15/2020 12/31/2019

40

Conservatives: 365

Labour: 202

SNP: 47

LibDems: 11

Other: 25

House of Commons Composition


UK: Brexit… The end of the beginning

As of December 2019

SOURCE: House of Commons, PIMCO

• With an outright majority of 80 seats, PM Johnson can govern without having to pander excessively to the right wing of the Conservative party or

Northern Ireland’s DUP.

• We expect the UK and EU to negotiate a limited free trade agreement, concentrated on goods. If the trade negotiations are inconclusive, we

expect the EU to agree to a very narrow deal or to implement temporary side deals, in effect smoothing the transition into WTO trading terms. In

any event, we see the risk of the UK ending the transition period with no deal as low.

Key dates on the current Brexit timeline

Jan 31: UK leaves EU but stays in transition period

March: UK-EU trade negotiations begin

Dec 31: Transition period set to end

June 30: Deadline to extend the transition period

41

Key European investment themes

Source: PIMCO.

Interest Rate Exposure

• Favour US treasuries over European or UK government bonds

• Within German government bonds (Bunds), focus on 10 year point of the curve vs

shorter/longer ends

Regional Focus • Modest overweight to peripheral Eurozone countries, particularly Italy and Spain given

attractive spreads and a supportive stance from the ECB

Volatility • Sell Volatility on European rates as it continues to appear elevated relative to the level of rates

Financials • Favour financial credits, in particular in the UK given strong capital, a more liquid balance

sheet and attractive valuations

• Favour exposure to select peripheral banks

Securitized • We view securitized credit favorably, particularly UK RMBS and Danish callable mortgages,

AAA rated assets which are an attractive source of “safe spread”

Currency • Modest overweight to GBP based on our view of a more organized Brexit outcome

42

Appendix

Past performance is not a guarantee or a reliable indicator of future results.

Forecast

Forecasts, estimates and certain information contained herein are based upon proprietary research and should not be interpreted as investment advice, as an offer or solicitation, nor as the

purchase or sale of any financial instrument. Forecasts and estimates have certain inherent limitations, and unlike an actual performance record, do not reflect actual trading, liquidity constraints,

fees, and/or other costs. In addition, references to future results should not be construed as an estimate or promise of results that a client portfolio may achieve.

Hypothetical Example

Hypothetical example for illustrative purposes only. Hypothetical and simulated examples have many inherent limitations and are generally prepared with the benefit of hindsight. There are

frequently sharp differences between simulated results and the actual results. There are numerous factors related to the markets in general or the implementation of any specific investment

strategy, which cannot be fully accounted for in the preparation of simulated results and all of which can adversely affect actual results. No guarantee is being made that the stated results will be

achieved.

Investment Strategy

There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term,

especially during periods of downturn in the market.

Outlook

Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market

conditions, and each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. Outlook and strategies are subject to change without

notice.

Risk

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 the

current low interest rate environment increases this risk. Current 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. Commodities contain heightened risk, including market, political, regulatory and natural conditions, and may not be

suitable for all investors. Currency rates may fluctuate significantly over short periods of time and may reduce the returns of a portfolio. Derivatives may involve certain costs and risks, such as

liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested.

Equities may decline in value due to both real and perceived general market, economic and industry conditions. 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. Sovereign securities are generally backed by the issuing government.

Obligations of U.S. government agencies and authorities are supported by varying degrees, but are generally not backed by the full faith of the U.S. government. Portfolios that invest in such

securities are not guaranteed and will fluctuate in value.

!mk_Secular_Cyclical_Outlook_EMEA_app

43

Appendix

!mk_Secular_Cyclical_Outlook_EMEA_app

High yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do

not. 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. Income from municipal bonds may be subject to state and local taxes and at times the alternative minimum tax.

Swaps are a type of derivative; swaps are increasingly subject to central clearing and exchange-trading. Swaps that are not centrally cleared and exchange-traded may be less liquid than

exchange-traded instruments. 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. Certain U.S. government securities are backed by the

full faith of the government. Obligations of U.S. government agencies and authorities are supported by varying degrees but are generally not backed by the full faith of the U.S. government.

Portfolios that invest in such securities are not guaranteed and will fluctuate in value.

Strategy Availability

Strategy availability may be limited to certain investment vehicles; not all investment vehicles may be available to all investors. Please contact your PIMCO representative for more information.

This material contains the current opinions of the manager and such opinions are subject to change without notice. This material is distributed for informational purposes only and should not be

considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be

reliable, but not guaranteed.

This presentation contains the current opinions of the manager and such opinions are subject to change without notice. This presentation has been distributed for informational purposes only and

should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources

believed to be reliable, but not guaranteed. No part of this presentation may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a

trademark or registered trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. ©2020, PIMCO

Cyclical Economic Outlook Seven Macro Themes for 2020 · Market size, market value, and OAS based...

Documents

Transcript of Cyclical Economic Outlook Seven Macro Themes for 2020 · Market size, market value, and OAS based...