PIMCO: Energy shocks, rising yields, and the case for bonds
Dan Ivascyn, Group CIO at PIMCO, discusses the market implications of rising geopolitical tensions in the Middle East, the outlook for interest rates and fixed income, and how investors should be thinking about credit markets amid growing capital needs in areas like AI infrastructure in his View from the Investment Committee. A few highlights include:
On geopolitics and market uncertainty
“For the foreseeable future, markets are going to be very focused on what occurs in the Middle East. If we see deterioration in the situation there - more challenges on the supply side in energy markets - we could see rates trend higher over the short term. We think this scenario would also be quite bad for risk markets. The flip side is if we get any type of stability - which we think is still the modal outcome - there's a lot of room for inflation to improve over the intermediate term. And you can see a situation where bond yields begin dropping again as well.”
“So the bottom line is that there's a lot more uncertainty today; a legitimate, at least short-term focus on the situation within the Middle East, and an inflation situation that's going to lead to more uncertainty, all in the context of a market that offers pretty good value today.”
On rates, yields and fixed income opportunities
“First point is that with a longer term time horizon, there's great value in the market. We said that at the beginning of the year. Now, given the inflation shock, yields across the high-quality area of the market are a bit higher as well. If you look at them in a long-term context, there’s real good value in absolute terms, yields today that are well above this still elevated inflation rate and yields today that look attractive relative to equity valuations as well. For someone who has an intermediate time horizon, this is an attractive environment for income or yield generation.”
“The second point is that you have an exciting, target-rich global opportunity set across global government bond markets, corporate bond markets, asset-backed finance markets, and local currency markets.”
On moving out of cash
“Today, you can move out of cash. You can buy a five year or 10-year maturity type instrument and lock in these attractive high-quality bond yields for many years to come. When you go back through history and look at other energy shocks, if not addressed, they typically quickly turn into growth shocks on the follow. That's an environment where your cash rate is going down. Given some of the volatility in recent years in bonds, it's not the easiest thing to do, but we do think you're getting paid for even incremental duration extension here or up in the current environment.”
On credit markets and AI-related investment
“Equity markets around the globe are near all-time highs. Credit spreads in general are close to all-time highs as well. But there's a lot going on beneath the surface. We think we are in the midst of the first sustained default or loss cycle in many, many years. And it's critically important to do really good bottom-up credit work to protect portfolios from what will be higher losses than the market's grown accustomed to. The point is to be selective.”
“There are also incredible needs for capital investment within the technology sector in particular - AI infrastructure, related energy infrastructure - and it's creating some risks. It's not a sector where we want to be overweight given the uncertainty, the volatility, the need to predict how companies are going to make money in this space. But because of the massive funding needs, you can be defensive in terms of overall exposure and unlock tremendous value.”
“This is an area where you can, given the size of the funding needs and an increasingly motivated set of borrowers, drive transaction terms, pick up spread for taking on additional complexity, create nuance within these structures that could lead to better transactional liquidity than the market would initially anticipate, and in the process, create value for end investors.”