Pimco Sees 'Fragmentation Era' in Annual Secular Outlook

Bloomberg

21 hours ago

00:00
A new secular outlook. Always a fantastic team effort from you and the team every single every single June, I believe. Yeah, the era of fragmentation. Let's just start that before we get into the debt dynamics. What is that and what does it mean for the path forward? Very straightforward. The world's fragmenting into regional security alliances, trading blocs, currency zones. The process has been underway for a while, but it's accelerated under Trump 2.0. We point out it has important implications for the economy and markets. We see business cycles being amplified, markets being more volatile. But importantly, there are opportunities for investors in the fragmentation era to identify what's driving returns and repricing risk. Well, let's identify what the economic characteristics are of the era of fragmentation and what it means for the so-called long bond. Does it mean a less dependable bond bed for a 30 year maturity? Well, we're not sure. We think what it does mean is there's a very large stock of debt in the US and around the world as we come into the era of fragmentation. And so we do see already in market pricing a higher term premia. Our judgment right now is that the very long into the curve for most investors, you're not getting paid enough to take on three times the interest rate risk, which is our preference for the belly of the curve. So that's the most immediate point I guess I would make. What do you what's your reaction when you hear Jeffrey Gundlach say a reckoning is coming to the US in the US debt market? Our baseline view is that a reckoning is inevitable, but not our baseline for the next five years. We think the action forcing event in Washington to get our fiscal house in order will probably be in the next decade when the Medicare, Medicare and Social Security trust funds are exhausted. We could be wrong at some level. I hope we're wrong because an earlier reckoning means that we get our fiscal house in order. But our baseline is that that's that's something in the next decade. When you see these concerns of the US debt market and then you're also have this view that there's this fragmentation going on in the world. What does this mean for us? Exceptionalism? Is it over? Is it waning or potentially could it re-emerge in Trump to point out? We think it could re-emerge for the following reason. As we come into the era of fragmentation, there's a lot to like about the US. Strong productivity growth and innovative economy. More or less efficient capital markets. And. And those attributes have not gone away. There's a lot of uncertainty now, a lot of it generated about US trade policy and security policy. But over time, Anne-Marie, that will get sorted out. And as that goes into the rear view mirror, we think there's a decent shot that the exceptionalism mean returns. Can we just finish on the Federal Reserve? Oh, the kind of new considerations in monetary policy officials need to have in the moment that even a team, a framework, what's changed for them? I think that it will make their job more difficult in the sense that the Fed benefited enormously and all central banks did from globalization. And Jay Powell and I used to talk about that at the time is that the era of globalization lowered the cost of goods, increased efficiency, it put downward pressure on inflation. Indeed, the price of goods fell on average in the nineties up until the pandemic. And so as globalization goes into reverse and in the era of fragmentation, that process will be accelerating. It's going to make all central banks job at the margin harder because you will not have that disinflationary force from globalization. Do you think it makes it more difficult to respond to unfair shocks and respond quickly enough? I think at the margin, probably for all central banks, they have a little bit less room to respond preemptively to news of a slowing economy simply because they don't have the tailwind of inflation being a bit below target for ten or 15 or 20 years. And they want to keep inflation expectations anchored. So again, I think these effects are more at the margin, but I think it's less likely that you get preemptive moves to going into downturns. I remember a phrase of yours, an ounce of protection is worth a pound of cure. It doesn't feel like they have that luxury this time around. They have less of a luxury. And, you know, John, there is some path dependence here. I mean, we would be having a different conversation if inflation for the last four years had not been well above 2%. And I won't even use the T word here. And so I think there is some path dependence here for all central banks Christine Lagarde, Andrew Bailey and others, central banks. At the end of the day, one inflation expectations to be anchored and they want to be credible. So I think that is relevant here.