Download Keynote Address: Navigating the New Neutral

Keynote Address:
Navigating the
New Neutral
Scott Mather
Presenter
Chief Investment Officer
U.S. Core Strategies
PIMCO
Agenda
1.What is the New Neutral?
2.What does it mean for investors?
pg 2
1. What is the New Neutral?
pg 3
Ye olde normal?
16
Three centuries of long-term yields in the U.K.
14
12
Yield (%)
10
8
6
4
2
0
1713
1763
1813
1863
1913
1963
2013
2014
The high interest rates of the 70s and 80s, not today’s low yields, were the aberration
As of 30 September 2014
SOURCE: Bank of England
pg 4
The New Neutral in a nutshell
Aging population, weak productivity growth, debt overhang
and muted inflation
Slow growth (real and nominal)
Low interest rates
Refer to Appendix for additional investment strategy, outlook, and risk information.
pg 5
Building blocks of nominal growth
Growth in the labor force
+
Increase in productivity
+
Inflation
≈
Potential growth in Nominal GDP
Rapid GDP growth is unlikely in an environment of low inflation with an aging population
Refer to Appendix for additional investment strategy, outlook, and risk information.
pg 6
The developed world is getting older fast
1.4
Developed regions age group
Population (Billions)
1.2
65+
1.0
0.8
inflationary
growth
deflationary
contraction
0.6
+14%
-8%
15-64
0.4
0.2
0-14
0.0
1983
2013
2043
Dependency issues aside, the aging of the population implies slower growth
As of 31 August 2014
SOURCE: UN
pg 7
U.S. labor force is entering a post-baby boom bust…
YoY growth (5y mov. avg.)
3%
Annualized labor force growth rate
2%
1%
0%
1959
1964
1969
1974
1979
1984
1989
1994
1999
2004
2009
2014
Demographic and other structural factors suggest labor force growth may stagnate
As of 30 September 2014
SOURCE: Bureau of Labor Statistics
Refer to Appendix for additional forecast, outlook, and risk information.
pg 8
…leaving productivity to do the heavy lifting
YoY growth (5y mov. avg.)
4%
U.S. nonfarm business sector output per hour
3%
2%
1%
0%
1959
1964
1969
1974
1979
1984
1989
1994
1999
2004
2009
2014
Productivity growth surged above 3% in the tech boom, but has averaged below 2% recently
As of 30 June 2014
SOURCE: Bureau of Labor Statistics
Refer to Appendix for additional forecast, outlook, and risk information.
pg 9
Potential real growth will be limited
CBO Potential Real GDP
YoY growth (5-year mov. avg)
6%
Actual Real GDP
Forecast
5%
4%
3%
2%
1%
0%
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
2020
The drivers of real growth indicate a relatively moderate growth trajectory going forward
As of 30 June 2014
SOURCE: Bureau of Economic Analysis, CBO, PIMCO
Refer to Appendix for additional forecast, outlook, and risk information.
pg 10
Finally, inflation completes the picture of nominal growth
3.0
U.S. core PCE
opportunistic disinflation
YoY change (%)
2.5
proactive reflation
2.0
1.5
1.0
0.5
0.0
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
Even if the Fed meets or exceeds its 2% inflation target, nominal GDP growth will be limited
As of 31 August 2014
SOURCE: Bureau of Economic Analysis
Refer to Appendix for additional forecast, outlook, and risk information.
pg 11
Growth and bonds yields are closely intertwined
20
Percent
15
UST 10Y
UST 10Y - Avg
Nom GDP YoY
1955-1979 Averages
Nom GDP: 7.9%
UST 10Y: 5.6%
Nom GDP YoY - Avg
1980-Current Averages
Nom GDP:
5.6%
UST 10Y:
6.6%
10
5
0
-5
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
And the relationship has varied over time
As of 30 June 2014
SOURCE: Federal Reserve, Bureau of Economic Analysis
Refer to Appendix for additional investment strategy, outlook, and risk information.
pg 12
The New Neutral for interest rates?
Nom GDP YoY
20
FF rate
UST 10Y
Percent
15
10
5
Neutral?
0
-5
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
If nominal GDP grows at around 4%, then Fed Funds and bond yields may not have far to rise
As of 30 June 2014.
SOURCE: Federal Reserve, Bureau of Economic Analysis, PIMCO
Refer to Appendix for additional outlook information.
pg 13
2. What does it mean for investors?
pg 14
We are operating in a world of central bank policy divergence…
Fed
6
ECB
BoJ
90-day MM
futures imp.
yields
5
4
Rate (%)
BoE
3
2
1
0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Growth and policy divergence will lead to diverging interest rates
As of 20 October 2014
SOURCE: Bloomberg
Refer to Appendix for additional investment strategy, outlook, and risk information.
pg 15
…so currencies should reflect rates divergence
Euro (LHS)
Exchange rates
Yen (RHS)
100
1.37
102
1.34
104
1.31
106
1.28
108
1.25
Dec '13
110
Mar '14
Jun '14
Sep '14
The U.S. dollar should strengthen, especially against the euro and yen
As of 20 October 2014
SOURCE: Bloomberg
Refer to Appendix for additional investment strategy, outlook, and risk information.
pg 16
Yen/$ (axis inverted)
$/Euro
1.40
YTD moves should be put in historical context
U.S. TW major currency dollar
(Mar '73=100)
115
Trade-weighted U.S. dollar
105
95
85
75
65
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
While the dollar has rallied recently, there is room for further appreciation
As of 17 October 2014 (weekly close)
SOURCE: Bloomberg
Refer to Appendix for additional investment strategy, outlook, and risk information.
pg 17
The Fed has been focused on reflating the economy…
October 9th: "I have been concerned that the market path of interest rates is lagging behind what the committee is thinking."
October 16th (after sell-off): “Inflation expectations are declining in the US…for that reason I think that a logical policy
response at this juncture may be to delay the end of the QE.”
James Bullard,
St. Louis Fed President
October 11th: “if foreign growth is weaker than anticipated, the consequences for the U.S. economy could lead the Fed to
remove accommodation more slowly than otherwise.”
Stanley Fischer,
Vice Chair of the Federal
Reserve
September 22nd: “Right now with inflation running below 2% we really need the economy to run a little hot for at least some
period of time to actually push inflation back up to our objective.”
William Dudley,
NY Fed President
Past is prologue?
1995: “[W]hen the goals [of price stability and output stability] conflict and it comes to calling for tough trade-offs,
to me, a wise and humane policy is occasionally to let inflation rise even when inflation is running above target.”
Janet Yellen,
Chair of the
Federal Reserve
pg 18
…but inflation expectations are low and falling
2.75
U.S. 10-year breakeven inflation
Rate (%)
2.50
2.25
2.00
1.75
Oct '11
Apr '12
Oct '12
Apr '13
Oct '13
Apr '14
Oct '14
TIPS appear attractive, especially as a means to protect against future surprises in inflation
As of 20 October 2014
SOURCE: Bloomberg
Refer to Appendix for additional investment strategy, outlook, and risk information.
pg 19
Growth and inflation trends in the eurozone are worrying…
Germany expectations of economic growth (LHS)
Eurozone inflation YoY (RHS)
3.5
60
3.0
40
2.5
20
2.0
0
1.5
-20
1.0
-40
0.5
-60
Oct '10
Apr '11
Oct '11
Apr '12
Oct '12
Apr '13
Oct '13
Apr '14
0.0
Oct '14
Growth sentiment and inflation are falling
As of 20 October 2014
SOURCE: Eurostat, ZEW
Refer to Appendix for additional investment strategy, outlook, and risk information.
pg 20
Eurozone MUICP YoY (%)
ZEW survey (% balance)
80
10-year nominal rate - inflation (%)
…so the ECB should remain accommodative
5
U.S.
Real yields
Germany
Italy
Spain
4
3
2
1
0
-1
-2
Sep '09
Sep '10
Sep '11
Sep '12
Sep '13
Sep '14
The ECB wants negative real rates across the eurozone
As of 30 September 2014
SOURCE: Bloomberg, PIMCO.
Refer to Appendix for additional investment strategy, outlook, and risk information.
pg 21
Mexico’s improving fundamentals present an opportunity…
Gross govt debt/GDP (%)
120
Comparing Mexico and the U.S.
Mexico debt/GDP
Moody's rating (Mexico)
U.S. debt/GDP
A3
100
Baa1
80
Baa2
60
Baa3
Ba1
40
Ba2
20
0
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
Improving credit characteristics could separate Mexico from the rest of EM
As of 20 October 2014
SOURCE: PIMCO, Moody’s, IMF
Refer to Appendix for additional investment strategy, outlook, and risk information.
pg 22
…and could lead to yield curve convergence
MXN swaps
8
USD swaps
7
Rate (%)
6
5
4
3
2
1
0
3M
1YR
2YR
3YR
5YR
7YR
10YR
12YR
15YR
20YR
30YR
A steep curve and structural reforms make Mexican rates attractive
As of 20 October 2014
SOURCE: Bloomberg, PIMCO
Refer to Appendix for additional investment strategy, outlook, and risk information.
pg 23
Investing in a New Neutral world
Returns from
beta may be
lower
 Active management will be a larger component
of returns
 Alpha opportunity set remains robust
 Flexibility is required to exploit Secular and
Cyclical trends
What we like





TIPS
Short-dated corporates
U.S. dollar
Select global sovereigns (Italy, Spain, Mexico)
Non-Agency mortgages
Refer to Appendix for additional investment strategy, outlook, and risk information.
pg 24
Appendix
Past performance is not a guarantee or a reliable indicator of future results.
FORECAST
Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or
investment product. There is no guarantee that results will be achieved.
INVESTMENT STRATEGY
There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of
downturn in the market.
OUTLOOK
Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions, and each investor
should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. Outlook and strategies are subject to change
without notice.
RISK
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 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. Equities may decline in value due to both real and perceived general market, economic and industry conditions. 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. Derivatives may involve certain costs and risks, such as liquidity, interest rate,
market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested. Derivatives may involve certain costs and risks such
as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested. Management risk is the
risk that the investment techniques and risk analyses applied by PIMCO will not produce the desired results, and that certain policies or developments may affect the investment techniques available to PIMCO in connection
with managing the strategy.
This material contains the current 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 is a trademark or registered trademark of Allianz Asset Management of America L.P. in the
United States and throughout the world. THE NEW NEUTRAL and YOUR GLOBAL INVESTMENT AUTHORITY are trademarks or registered trademarks of Pacific Investment Management Company LLC in the United States and
throughout the world. ©2014 PIMCO
PIMCO Investments LLC, distributor, 1633 Broadway, New York, NY 10019 is a company of PIMCO.
pg 25
Keynote Address:
Navigating the
New Neutral
Scott Mather
Presenter
Chief Investment Officer
U.S. Core Strategies
PIMCO