Into the Unknown


  • With Trump, Brexit, Italy’s “No” and China’s currency woes, the world economy and markets have embarked on a journey into the unknown. Our baseline prognosis for 2017 is broadly unchanged from September, but our confidence in any particular economic scenario is low. The reason: The world has now fully arrived in the radically uncertain, “stable but not secure” predicament we described in our Secular Outlook back in May.
  • The only certainty in our view is that the tails of the distribution of potential macro outcomes have become fatter. Left-tail risks are defined by rising debt, monetary policy exhaustion and the populism-powered transition from globalization to de-globalization. By contrast, right-tail opportunities may emerge from potential deregulation, awakening animal spirits and the accelerating transition from exhausted monetary to growth-supportive fiscal policies.
  • Rather than betting big on one direction or the other, investors today should consider a patient approach and aim for capital preservation until the veil of uncertainty over future policies starts to lift. With markets prone to overshooting and undershooting and likely to swing back and forth between our secular New Neutral and a potential “New Paradigm,” better opportunities to deploy liquidity should emerge in the course of 2017.

A U.S. President-elect Donald Trump, a euphoric market response and a resounding “No” to Italian constitutional reform – the stage was perfectly set for lively discussions when PIMCO’s investment professionals gathered in Newport Beach or in front of the video screens in our 12 global offices for the December Cyclical Forum to deliberate on our outlook and strategy for 2017.

The assembled crowd was acutely aware that the “stable but not secure” macro environment that we had envisaged for the next three to five years at our annual Secular Forum in May had arrived – and with a vengeance!

Since May, all three key risks that we saw on the secular horizon – elevated and rising debt levels, monetary policy exhaustion and the ascent of populism – have either already materialized or become more real, and markets have woken up to our long-held view that inflation risks over the secular horizon were seriously underappreciated and underpriced.

Who would have thought back in May that within the following six months the UK would vote for Brexit, Donald Trump would be elected president of the United States, Italy would vote “No” on reform, and that markets would like it? And who would have thought that both Bank of Japan Governor Haruhiko Kuroda and European Central Bank President Mario Draghi would acknowledge (through their actions rather than words) so soon that quantitative easing (QE) and negative interest rates are reaching the limits of their effectiveness and that these central banks’ inflation targets are essentially unachievable (see PIMCO Blog post, “ECB Policy: 1% Is the New 2%”)?

Five guiding principles and three difficult transitions

Against this unprecedented backdrop, we decided at our December forum to base our cyclical outlook and our investment strategy on five guiding principles, which we will review regularly as events start unfolding:

The first principle is that the distinction we normally make between secular (three to five years) and cyclical (six to 12 months) forces and timeframes is fuzzier than usual in this new macro environment. Both hopes and fears of what the Trump presidency might bring over the secular horizon are driving current market moves, which in turn might create powerful feedback loops between markets, the economy and actual policies over our cyclical horizon, both in the U.S. and abroad. And so we spent more time than usual at a Cyclical Forum discussing secular forces and their interaction with cyclical trends, aided by the presence and insights of several of PIMCO’s advisors, including Ben Bernanke, Michael Spence, Gene Sperling and Ng Kok Song.