View from the Investment Committee

Defense Still the Best Offense in the Bond Market

Group CIO Dan Ivascyn shares that while PIMCO portfolios have been taking on a bit more risk, they continue to maintain a defensive tone given the uncertain environment ahead.

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David Fisher, Head of Traditional Product Strategies: Hi, I’m David Fisher, and I’m here once again with group CIO Dan Ivascyn to talk about some of the recent discussions taking place in PIMCO's Investment Committee or IC.

So one topic that's been on the mind of investors lately is the shape of the US yield curve.

Chart: A line graph charts the 30-year U.S. Treasury yield curve and highlights 3-month yields (2.46) and 10-year yields (2.44).

In March, we saw the yield curve invert briefly with the yield on the ten-year note falling below that of the three-month bill. And a lot of investors suggested that this was a sign that recession might be imminent. So what's the IC's view on this? Is a recession imminent in the US? 

Daniel J. Ivascyn, Group Chief Investment Officer: We don't think a recession's imminent. In fact we still see generally positive growth across the globe this year. We see the US economy growing in the two percent range as well. So certainly, as yield curves flatten we want to take notice. We want to understand what's going on, and we do think that there's more uncertainty on a go forward basis. In fact, we have a quite consequential and highly uncertain US presidential election coming up next year in this country.

Shots of cargo ships and a shipping port.

We still have considerable uncertainty around global trade, in particular China. But we think that it’s also premature to suggest that a recession’s right around the corner simply because we have seen some inversion in a portion of the U.S. curve.

David: So what are the investment implications? How is PIMCO positioning along the yield curve these days?

Dan: PIMCO has spent a lot of time talking about the overall amount of interest rate exposure we want to take across portfolios.

Shots of PIMCO employees working.

And in select strategies—many strategies—we've brought that exposure down a little bit.

We do think rates will remain relatively range bound, but given the rally we saw in the first quarter relative to our own fundamental economic view, we do think that rates are at risk of a second half pullback. Regarding our duration positioning and where we take that exposure, we have been very concentrated in the intermediate part of the yield curve, in that five to seven-year maturity spectrum. And that area of the yield curve has benefitted the most from markets beginning to react to a more dovish federal reserve.

So given the very strong performance in that area of the yield curve, we still like that maturity, we just like it a little bit less.

David: The fed’s talked about the fact that policy rates are now close to neutral. The market is in fact now pricing in easing from the fed before tightening. What are the implications of where rates are going near term?

Dan: We do agree that central banks led by the US Fed will continue to be quite dovish.

Shots of U.S. Federal Reserve building and photograph of Fed chairman, Jerome Powell

The US Federal Reserve has gone out of their way the last couple of months communicating to market participants that they intend to be very, very cautious regarding future rate hikes. And they today see policy risks as being quite symmetrical, meaning that they think that there's almost an equal chance that rates could go lower rather than higher when the fed decides to move again.

We're a little bit cautious. Or put another way, we think that perhaps markets have gotten a little bit ahead of themselves. We think that—as I mentioned earlier—growth will remain positive around the globe. There's even a chance that you could see some reacceleration later this year. And the interest rate markets right now aren't priced for that risk of reacceleration and growth.

So if we saw some improvement on the policy side, a strong trade agreement with China, a little bit reduced political tension here in this country, we very well could see later on in this year, and even our own economic work suggests we could see a little bit of an uptick in growth, even an uptick in inflationary pressure. And that would lead to likely higher rates.

David: So one thing for PIMCO portfolios in the fourth quarter was the IC's relative defensiveness. Given that central banks have responded to some of that volatility in the markets by effectively going on hold, becoming much more dovish, is defensiveness still appropriate?

Dan: We do think that on the margin portfolios could take a bit more risk. However, we do think that having a defensive mindset remains prudent.

We've talked about housing related exposure as being a very attractive alternative to US corporate credit. Another great area to diversify, at least on the margin, are emerging markets. Emerging markets typically do well when central banks are on hold and when global growth is steady and positive. There’s certainly risks to that asset class and risks to our economic outlook, but we do see within select portions of the emerging market sector some exciting areas to diversify portfolios as well. So a little bit more offense given a more positive environment in regards to central banks, but still looking to be resilient, anticipating future bouts of volatility.

If we could protect it during those periods, that gives us the ability to go on offense when others in the marketplace are needing liquidity, needing to reduce risk.

David: Well, thanks for joining us, Dan. And thanks to you as well. We'll see you next time.

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