(Jan 15): The uncertainty likely to be injected into markets this year by US President-elect Donald Trump promises to be yet another driver of attractive bond returns, according to Pacific Investment Management Co (Pimco).
Unpredictability, paired with rising Treasury yields and diminished expectations for central bank easing is seen generating long-term returns for fixed-income investors, according to the firm overseeing the world’s largest actively managed bond fund — which stands to gain from any inflows into debt.
“The incoming administration’s protectionist proposals have the power to reshape trade relationships and alter economic dynamics worldwide,” according to economist Tiffany Wilding and chief investment officer for global fixed income Andrew Balls. The pair called out bonds’ stabilising appeal amid growing economic agita as the US transitions to new leadership in a note titled “Uncertainty Is Certain”.
The firm’s US$171 billion (RM769.97 billion) Pimco Income fund recorded some of the strongest inflows among active US bond funds in 2024, according to Morningstar data. The fund has outperformed a Bloomberg aggregate gauge of the bond market and most of its rivals over the past five years.
“Bond yields are attractive at a time when equity valuations and credit spreads are not, giving high-quality fixed income a favourable starting point,” the pair wrote in their latest outlook. “Markets are pricing in terminal policy rates for global central bank easing cycles that appear somewhat high relative to our baseline outlook.
Among US Treasuries, even with the potential for a lengthier Federal Reserve pause on interest-rate cuts, Pimco views intermediate-maturity yields as attractive relative to the firm’s baseline long-term target of 0% to 1% for the neutral rate — where the economy is neither growing nor restricted.
The recent sell-off in Treasury yields — the 10-year hit 4.8% on Monday, a level last seen in November 2023 — equates to having more interest-rate exposure in the five- to 10-year maturity range, according to Wilding and Balls.
Pimco, which manages US$2 trillion in assets, was bullish on five-year debt last October, when the benchmark was at 3.85%. That call has yet to pan out; the rate is now around three-quarters of a percentage point higher.
The Newport Beach, California-based bond manager also renewed a call for a steeper Treasury yield curve — where short-term yields fall below those on longer-maturity bonds — similar to its views in the weeks before the presidential election. That call has fared better, albeit in choppy trading due to fears that Trump will prioritise growth over the US’ growing debt pile. The gap between the two-year and 10-year resumed a climb in December.
Wilding and Balls see such a path as being “driven by central bank easing and a continuation of the recent rise in term premium amid concerns about elevated sovereign debt”.
As such, Pimco is “underweight on the 30-year area of the US yield curve”.
“There is significant near-term potential for lower central bank rates outside the US,” according to the asset manager, especially if the Trump administration pursues “more aggressive trade policies that weaken global growth and weigh on commodity prices”.
In such a scenario, Pimco prefers UK and Australia debt “based on valuations and economic risks compared with the US”.
“The balance of potential policy outcomes increases near-term US inflationary risks while posing greater downside risks to growth” for other countries, Wilding and Balls wrote, “particularly those with high global trade exposure that run persistent surpluses with the US”.
Still, there is scope for the incoming US administration to move more gradually.
“President-elect Donald Trump’s tolerance for US equity market volatility is a key question for the outlook,” they said. “Aggressive short-term measures to reverse long-term trends would likely contribute to economic disruptions, near-term currency volatility, and US equity market underperformance.”
Other points of consideration for investors over the next six to 12 months:
- US Treasury Inflation-Protected Securities “remain a reasonably priced hedge against higher inflation outcomes”.
- “The long-term outlook for US government debt is likely to remain a significant concern,” and Pimco said “any meaningful deficit improvement will be difficult, with the expected extension of the Tax Cuts and Jobs Act — Trump’s first-term bill — and some additional tax cuts”.
- Owning the US dollar versus the euro, Canadian dollar, and Chinese yuan “can offer reasonable return potential in the baseline scenario and may offer protection against more adverse trade outcomes”.
- For US credit, “the range of outcomes appears skewed towards wider versus tighter spreads given the balance of global risks”.
- The Bank of Japan is seen hiking its policy rate by a half-point “as higher inflation expectations support underlying inflation despite currency volatility”.
Uploaded by Tham Yek Lee