Economic and Market Commentary

Do Rates Have Room to Rally?

How should investors be thinking about duration? Andrew Balls, CIO Global Fixed Income, and Joachim Fels, Global Economic Advisor, provide our take on relative duration positioning across the regions and why U.S. rates offer the most room for rally.

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Tina Adatia, Fixed Income Strategist: Joachim, how is PIMCO thinking about relative duration positioning across the regions?

Joachim Fels, Global Economic Advisor: I guess the first thing to say is, ten-year yields of 1.5%, 1.6% in the U.S., it’s really low. I mean, it’s lower than what you would normally expect outside of recessions. But as discussed, recession risk is elevated,

Chart: A chart shows five secular trends that have the potential to disrupt the global economy, financial markets and portfolios over the next several years: China, populism, demographics, technology and financial market vulnerability.

and there are all kinds of disruptions that might happen. You know, secular disruptions.

Chart: A chart compares current global yields to their respective lowest historic levels as of September 2019. The yields compared are U.S. 10-year Treasuries (highest yield levels), 10-year JGB, 10-year bund (lowest yield levels), and 10-year gilt.

And in that case, obviously, U.S. rates or U.S. bonds offer the most room for rally. They still have considerable upside in terms of prices. And downside in terms of yield, whereas, obviously if you get a big risk-off event, bond yields will go more negative, Japanese yields will go more negative, but there’s a lot more room for U.S. to rally. So this is why, I think, having an allocation and being in a bond portfolio, being overweight U.S. duration versus global duration makes a lot of sense to us. And you have to think about it in terms of the capital appreciation that you can get if things go wrong.

Andrew Balls, CIO Global Fixed Income: Yeah. So in terms of hedge yield, for example, if you’re a U.S. dollar-based investor, the hedge yield, the picture looks a little bit different, bonds, actually ten-year bonds yield a little bit more than ten-year treasuries, as you benefit from the FX hedge back to the U.S. dollar.

In terms of generating yield, or income, that’s a little bit more balanced. But as Joachim said, if you're looking for capital gains potential, that could clearly happen in the case of the U.S., in the event of a downturn.

Shots of Frankfurt, Germany and the European Central Bank building.

In Germany, say, you probably need a more significant shift on the part of the ECB towards even more negative yields to get significant moves there. And given the balance between the costs and the benefits of negative policy rates — it’s very unclear that that’s something the ECB can do very much more. So, the U.S. is the cleanest dirty shirt, if you’re looking for capital gain potential to hedge risk assets across a lot of our portfolios. You’ll see we’re overweight the U.S. versus the rest of the world.

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Past performance is not a guarantee or a reliable indicator of future results.

All investments contain risk and may lose value. 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 low interest rate environments increase this risk. 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. Sovereign securities are generally backed by the issuing government. Obligations of U.S. government agencies and authorities are supported by varying degrees, but are generally not backed by the full faith of the U.S. government. Portfolios that invest in such securities are not guaranteed and will fluctuate in value. Investing in foreign-denominated and/or –domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets.

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