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Pimco Makes the Case for High-Quality U.S. Bonds

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Andrew R. Michaud

• October 11, 2023

Bond giant Pimco is advocating for the ownership of high-quality U.S. bonds that yield about 5%-8%, rather than stocks. One of the main reasons for this recommendation is that these bonds are expected to provide downside protection if the U.S. economy experiences a slowdown in the next six to 12 months.

Outlook for Fixed Income Returns

According to a team at Pimco, consisting of Nicola Mai, a sovereign credit analyst, Tiffany Wilding, an economist, and Andrew Balls, the chief investment officer of global fixed-income, there is a belief that growth and inflation have reached their peak. Their analysis also suggests that markets may not be fully pricing in the risk of a recession, making fixed income investments more appealing.

The Risk of a Recession

The team from Pimco warns that achieving an economic "soft landing" would be an exceptional outcome, as historical data shows that instances of central banks increasing rates by more than 400 basis points have consistently resulted in recession since the 1960s.

Current Interest Rates and Inflation Target

The Federal Reserve has recently raised its policy interest rate to a 22-year high, with a range of 5.25% to 5.5%. In September, the Fed indicated that rates might need to remain higher than initially expected in order to control inflation and achieve their yearly target of 2%.

Impact on Treasury Yields

The statement from the Federal Reserve has already had some impact on longer-term Treasury yields. The 30-year BX:TMUBMUSD30Y rate briefly reached 5%, while the 10-year yield BX:TMUBMUSD10Y has set new highs for the year 2023.

In conclusion, Pimco's experts are advocating for high-quality U.S. bonds as an attractive investment option due to their potential for downside protection in the face of an uncertain economic landscape.

U.S. Bond Yields Retreat, Boosting Stock Market

The recent three-day rally of the Dow Jones Industrial Average (DJIA) and the S&P 500 index (SPX) received a much-needed boost as U.S. bond yields pulled back slightly. However, this rally was at risk of faltering on Wednesday.

Uncertainty Surrounding the U.S. Economy

The minutes from the Federal Reserve's September meeting revealed a sense of "high uncertainty" among officials regarding the future path of the U.S. economy. As a result, a cautious approach to interest-rate policy is being advocated.

The Appeal of Cash

In light of the current market conditions, the Pimco team suggests that cash may also be an attractive option. Short-term yields (BX:TMUBMUSD03M) are currently high relative to historical levels, providing flexibility and liquidity. However, it is important to note that these cash yields tend to be temporary.

Long-Duration Bonds: Greater Resilience in Portfolios

Pimco, which manages approximately $1.8 trillion in assets, emphasizes the potential benefits of longer-duration bonds in portfolios. These bonds lock in yields for a longer period of time and have the potential to appreciate even during a recession.

Caution Regarding Corporate Credit

While Pimco remains optimistic about longer-duration bonds, they express caution when it comes to corporate credit. This includes floating-rate corporate debt, such as bank loans and some legacy private credit. Pimco believes that these areas are already showing signs of strain due to higher interest rates.

It is important to note that this analysis does not account for the potential impact of a possible increase in leveraged loans if the Federal Reserve continues to maintain high interest rates.