Economic and Market Commentary

Too Hot, Too Cold: Anti-Goldilocks Economy

Learn why we believe higher inflation and lower growth is likely over the near term, how the risk of a recession has increased, and where volatility is providing opportunities for flexible investors.

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Text on screen: PIMCO

Footer Overlay: PIMCO provides services only to qualified institutions, financial intermediaries and institutional investors. This is not an offer to any person in any jurisdiction where unlawful or unauthorized.

Text on screen: Tina Adatia, Fixed Income Strategist

Tina Adatia: Joachim, can you explain what we mean by Goldilocks and anti-Goldilocks scenarios in the context of the global economy and give us an overview of the main conclusions from our outlook?

Text on screen: Joachim Fels, Global Economic Advisor

Joachim Fels: Yeah, well, Tina, I'll focus on the three main conclusions. So first of all, I think we are facing the exact opposite of the Goldilocks environment that we all got used to before the pandemic.  Goldilocks was an environment where the economy was neither too hot nor too cold.  It was just right, which was a great environment for financial markets.

FULL PAGE BULLETED LIST: TITLE – PIMCO’s Cyclical Outlook: LIST – Inflation is too hot, growth is too cold, Stagflationary and asymmetric shock, Monetary and fiscal policy rescue unlikely

We are now in anti-Goldilocks, which means we're in a situation where the economy is both too hot in terms of inflation, but also too cold, or will be too cold, in terms of growth. And the reason is really this stagflationary shock emanating from Russia's invasion in Ukraine and from the sanctions that followed it.

The second conclusion is that this is not only a stagflationary shock. It's also an asymmetric shock. Higher energy prices affect Europe much more than the US and some other parts of the world.

This shock creates a lot of winners and losers, winners both in emerging markets and also in developed markets, mainly the commodity producers, but again a lot of losers, particularly those that are net importers of raw materials, including food.

And then the third conclusion is that monetary and fiscal policy are unlikely to ride to the rescue this time as they did during the pandemic And as they did in the great financial crisis. This is very different, particularly for monetary policy, because inflation is so much higher and central banks are really laser focused on fighting inflation rather than supporting growth. So again, this increases the risk of not only a sharp slowdown in growth, but it also means that the risk of a recession over our cyclical horizon has increased.

Tina Adatia: Dan, can you give us your high level view on how PIMCO is thinking about portfolio positioning, given today's variability and what we're seeing in terms of the uncertainty and the level of volatility?

Text on screen: Daniel J. Ivascyn, Group Chief Investment Officer

Dan Ivascyn: Sure. Well, maybe just a comment on the volatility side, volatility has certainly increased. We've seen a much more significant increase and realized and implied volatilities within the interest rate markets. Volatility has increased on the equity side, but perhaps less than it should from a fundamental perspective.

FULL PAGE GRAPHIC: TITLE – Volatility across equities and rates has picked up. Two lines charts are shown; the title for the chart at left reads: Although modest in absolute terms, equity volatility has increased; the chart plots the VIX index from December 2019 – December 2021 and shows an huge increases at the start of 2020, due to the coronavirus and then leveling off until late 2021, when it starts to climb; albeit to much lower levels. The chart on the right is titled: Rate volatility has picked up amidst inflation concerns. The chart plots the CBOE Interest rate volatility index and shows how interest rate volatility began to pick up in late 2020 and has mostly been climbing ever since.

Equity markets have been more volatile, but we do think there's a bit of complacency embedded in the equity markets now and some segments of the credit markets. And again, I've been a little surprised by how well behaved those markets have been, at least on a relative basis, given the types of risks that we've talked about.

On the interest rate side, the volatility's elevated, certainly more appropriate given uncertainty in terms of inflation and central bank policy. But we do think that the higher volatility is providing opportunities for investors. There are some targeted opportunities to sell volatility, either explicitly or volatility embedded in certain high quality segments of the market, like agency mortgages as an example. But again, anytime you see this type of increase in volatility, combined with what is quite obvious on the ground in terms of a highly uncertain fundamental environment, again, it's just a reminder that investors should be cautious, should be patient. And liquidity and flexibility is very, very important because in some sense, you're long convexity or long volatility, when you have a lot of dry powder to react to what we think will be better opportunities in the coming months, and especially as we go into the end of 2022.

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Text on screen: For more insights and information, visit pimco.com

Text on screen: PIMCO

All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, call risk, 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 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. Equities may decline in value due to both real and perceived general market, economic, and industry conditions. Commodities contain heightened risk, including market, political, regulatory and natural conditions, and may not be appropriate for all investors. Diversification does not ensure against loss.

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CMR2022-0328-2098259

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