This article originally appeared in a modified form on on 12 April 2015.

I n one of my favorite films, George Lucas’ Star Wars, the Force is described as an energy field created by all living beings that surrounds and binds galaxies together. I am thinking about this today because, as I look around, the Force now seems to reside with the three powerful central bankers: Yellen, Draghi and Kuroda.

Recognize the existence of the Force
The central banks are absorbing a significant portion of the net supply of high quality sovereign bonds even as the Federal Reserve completed its quantitative easing (QE) in 2014 (Figure 1). This demand has pushed aggregate sovereign yields to incredibly low levels (Figure 2), while at the same time global credit spreads remain wider than their long-term average.

Understand what the Force can and can’t do
The Force can bring sovereign yields down. It can punish depositors for holding cash through negative rates. It can also encourage risk-taking as investors search for higher yielding assets to escape financial repression. This risk-taking can support prices of assets that central banks are not directly buying. This asset price appreciation can even support real economic growth through wealth effects. The jury is still out on the sustainability of that growth (we will leave that to the future historians).

The Force cannot make corporate managers smarter. It does not change the competitiveness of a company. It does not make its products suddenly more appealing, and it does not make a secularly declining business profitable. In short, it can’t make pigs fly – not for a long time, at least.

Investors should resist the Force and focus on avoiding these (temporarily) flying pigs. PIMCO’s elaborate global credit research process brings our credit research analysts, sovereign analysts, commodity analysts and global portfolio managers together to identify businesses and companies we believe have strong earnings potential, improving pricing power, superior asset coverage and high barriers to entry and those that focus on de-levering to generate value for credit investors. At the same time, it aims to avoid flying pigs. We will not be right all the time, but as history has shown, this process has been successful in avoiding such issues much more consistently than the aggregate market (Figure 3).

Expect periodic disturbances in the Force
The Force in consideration depends on smooth and flawless execution by central banks. We have seen many disruptions in the Force in the past and will continue to see them in the future. The next possible disruption comes from when the U.S. Fed will begin hiking rates. Our base case is around Q 3 2015. The Fed has attempted to reduce some volatility associated with the rate hike by lowering its dot forecasts for 2015 and 2016. Nonetheless, the implication for us is, first, to keep some dry powder with the aim to take advantage of the volatility or disturbance in the central bank’s Force. And second, be armed with the fundamental research for when that disturbance creates opportunities in the sectors and credits that pass our rigorous screening process.

Harness the Force but resist the urge to go to the Dark Side
The central bank policies provide a lot of interesting opportunities in the credit markets, but also a number of potential pitfalls. We evaluate credit using three broad considerations: fundamentals, technicals and valuations.

  •  Fundamentals

Broadly, corporate debt levels relative to profits look in line with long-term averages (Figure 4). Additionally, improving economic fundamentals in the U.S. – as evidenced by the declining unemployment rate and incremental cash in consumers’ pockets through lower energy costs – provide a supportive backdrop for credit. Similarly, in Europe, stabilizing and improving Purchasing Managers Index (PMI) data support credit fundamentals.

  • Technicals

This is where central bank policy, particularly now in Europe and Japan, remains most supportive for high quality global credit. By making deposit rates negative and/or by buying sovereign bonds, the European Central Bank and the Bank of Japan are pushing investors to look for other sources of high quality yield. Global high quality credit should benefit from this as investors look for relatively safe but higher sources of yield.

  • Valuations

Current credit spread are wider than the long-term average, making for an attractive entry point. Additionally, during prior rate-hike periods we have seen credit spreads tighten over time, since rate hikes are also associated with improving economic growth, which helps credit fundamentals (Figure 5).

Various areas in global credit look attractive to us given improving fundamentals, favorable technicals and attractive valuations. In the U.S., housing-related credits, banks and sectors tied to improvement in the U.S. consumer, like autos, airlines and lodging, look attractive. In Europe, we like peripheral sovereign spreads, exporters that benefit from weaker currency and subordinated bank securities (see the April 2015 Global Credit Perspectives for more details on opportunities in global credit markets today).

But it is also important to avoid going to the Dark Side – companies whose valuations are not justified by fundamentals but are artificially supported by central bank policies. To us, these would include select U.S. retail and technology companies that face risks of obsolescence in business models as the search for yield keeps spreads artificially compressed. Similarly, in Europe, credit spreads of many corporates now trade tighter than the sovereign spread and, hence, look less attractive. Finally, in Asia-Pacific we expect downside risk to China steel demand to translate into weakness in metals and mining companies in the region.

May the Force be with you
By virtue of their large balance sheets, central banks today are more powerful than ever before. This creates significant opportunities in global high quality credit sectors. Instead of being choked by negative or negligible yield on sovereign bonds, investors should look for opportunities elsewhere when seeking superior returns. But we believe fundamental credit research is now more important than ever. Focus on companies with improving business fundamentals, high barriers to entry and strong pricing power and those that are de-levering when seeking better risk-adjusted returns. And finally, recognize that this monetary policy reliance globally will likely lead to increased market volatility. Be prepared to take advantage of such opportunities.

The Author

Mohit Mittal

Portfolio Manager, Liability Driven Investment and Credit

View Profile

Latest Insights


PIMCO provides services only to qualified institutions and investors. This is not an offer to any person in any jurisdiction where unlawful or unauthorized. | Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660 is regulated by the United States Securities and Exchange Commission. | PIMCO Europe Ltd (Company No. 2604517) and PIMCO Europe Ltd - Italy (Company No. 07533910969) are authorised and regulated by the Financial Conduct Authority (12 Endeavour Square, London E20 1JN) in the UK. The Italy branch is additionally regulated by the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act. PIMCO Europe Ltd services are available only to professional clients as defined in the Financial Conduct Authority’s Handbook and are not available to individual investors, who should not rely on this communication. | PIMCO Deutschland GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Deutschland GmbH Italian Branch (Company No. 10005170963), PIMCO Deutschland GmbH Spanish Branch (N.I.F. W2765338E) and PIMCO Deutschland GmbH Swedish Branch (SCRO Reg. No. 516410-9190) are authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 32 of the German Banking Act (KWG). The Italian Branch, Spanish Branch and Swedish Branch are additionally supervised by the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act, the Comisión Nacional del Mercado de Valores (CNMV) in accordance with obligations stipulated in articles 168 and  203  to 224, as well as obligations contained in Tile V, Section I of the Law on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217/2008 and the Swedish Financial Supervisory Authority (Finansinspektionen) in accordance with Chapter 25 Sections 12-14 of the Swedish Securities Markets Act, respectively. The services provided by PIMCO Deutschland GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication. | PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-, Brandschenkestrasse 41, 8002 Zurich, Switzerland, Tel: + 41 44 512 49 10. The services provided by PIMCO (Schweiz) GmbH are not available to individual investors, who should not rely on this communication but contact their financial adviser. | PIMCO Asia Pte Ltd (8 Marina View, #30-01, Asia Square Tower 1, Singapore 018960, Registration No. 199804652K) is regulated by the Monetary Authority of Singapore as a holder of a capital markets services licence and an exempt financial adviser. The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Asia Limited (Suite 2201, 22nd Floor, Two International Finance Centre, No. 8 Finance Street, Central, Hong Kong) is licensed by the Securities and Futures Commission for Types 1, 4 and 9 regulated activities under the Securities and Futures Ordinance. The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Australia Pty Ltd ABN 54 084 280 508, AFSL 246862 (PIMCO Australia). This publication has been prepared without taking into account the objectives, financial situation or needs of investors. Before making an investment decision, investors should obtain professional advice and consider whether the information contained herein is appropriate having regard to their objectives, financial situation and needs. | PIMCO Japan Ltd (Toranomon Towers Office 18F, 4-1-28, Toranomon, Minato-ku, Tokyo, Japan 105-0001) Financial Instruments Business Registration Number is Director of Kanto Local Finance Bureau (Financial Instruments Firm) No. 382. PIMCO Japan Ltd is a member of Japan Investment Advisers Association and The Investment Trusts Association, Japan. Investment management products and services offered by PIMCO Japan Ltd are offered only to persons within its respective jurisdiction, and are not available to persons where provision of such products or services is unauthorized. Valuations of assets will fluctuate based upon prices of securities and values of derivative transactions in the portfolio, market conditions, interest rates and credit risk, among others. Investments in foreign currency denominated assets will be affected by foreign exchange rates. There is no guarantee that the principal amount of the investment will be preserved, or that a certain return will be realized; the investment could suffer a loss. All profits and losses incur to the investor. The amounts, maximum amounts and calculation methodologies of each type of fee and expense and their total amounts will vary depending on the investment strategy, the status of investment performance, period of management and outstanding balance of assets and thus such fees and expenses cannot be set forth herein. | PIMCO Taiwan Limited is managed and operated independently. The reference number of business license of the company approved by the competent authority is (107) FSC SICE Reg. No.001. 40F., No.68, Sec. 5, Zhongxiao E. Rd., Xinyi Dist., Taipei City 110, Taiwan (R.O.C.), Tel: +886 (02) 8729-5500. | PIMCO Canada Corp. (199 Bay Street, Suite 2050, Commerce Court Station, P.O. Box 363, Toronto, ON, M5L 1G2) services and products may only be available in certain provinces or territories of Canada and only through dealers authorized for that purpose. | PIMCO Latin America Av. Brigadeiro Faria Lima 3477, Torre A, 5° andar São Paulo, Brazil 04538-133. | No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world.

A word about risk: Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. All investments contain risk and may lose value.

This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO and YOUR GLOBAL INVESTMENT AUTHORITY are trademarks or registered trademarks of Allianz Asset Management of America L.P. and Pacific Investment Management Company LLC, respectively, in the United States and throughout the world. ©2015, PIMCO.