Partner Insight: Diverging markets, diversified portfolios

clock • 2 min read
Partner Insight: Diverging markets, diversified portfolios

With the paths of major economies poised to diverge, PIMCO discuss why they believe it is critical to act...

The global investment landscape is set to be transformed in the months ahead as the trajectories of major economies diverge more noticeably. Central banks, which tightened policy in unison to curb the pandemic inflationary spike, will likely follow varied paths when cutting interest rates. While many large, developed market (DM) economies are slowing, the U.S. has maintained its surprisingly strong momentum, with several supportive factors poised to persist.

Those growth drivers could keep U.S. inflation lingering above the Federal Reserve's 2% target over our six- to 12-month cyclical horizon. We still expect the Fed to start normalizing policy at midyear, similar to other DM central banks. However, the Fed's subsequent rate-cutting path could be more gradual.

An economic soft landing remains achievable in the U.S. Indeed, market pricing for both equities and the Fed's terminal policy rate appears to largely rule out the possibility of a recession. Yet we believe risks in both directions – from recession to rekindled inflation – remain magnified in the aftermath of unprecedented global shocks to supply and demand.

Amid this uncertainty, bonds offer attractive nominal and inflation-adjusted yields, plus the potential to weather a variety of economic conditions. Given today's flat yield curves, we believe intermediate maturities can offer a sweet spot between cash, where yields are fleeting and will decline when central bank rate cuts begin, and long-duration bonds, which could face pressure from rising bond supply needed to finance growing sovereign debt.

We see bond markets outside the U.S. as particularly attractive, based on our view that inflation risks are less pronounced in the rest of DM while recession risks loom larger. We particularly like the U.K., Australia, and Canada. Given U.S. resilience, we favor the U.S. dollar over the euro and other European currencies.

We continue to favour U.S. agency mortgage-backed securities and other high quality assets for their attractive yield and return potential. With interest rates elevated, we see greater pressure on both corporate borrowers and traditional lenders such as banks. Within private markets, we see increasing opportunities in asset-based and specialty finance.

Today's environment underscores the importance of global diversification, prudent risk mitigation, and constructing resilient portfolios through active management. We expect the traditional inverse correlation between stocks and bonds to resume, with the potential for fixed income investments to appreciate if the pricing of recession risk rises again.


This post is funded by PIMCO


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