The Beginning of the End? Key Takeaways From PIMCO’s Cyclical Outlook

Stormy weather was abundant in March: spring snowstorms in the Northeast of the U.S., a trade tussle with China that could escalate into a trade war, hawkish personnel changes in the White House, a Powell-led Federal Reserve that expects to overshoot the neutral policy rate, and the worst week for U.S. equities since January 2016.

Could this be the beginning of the end? This is the question we ask in our latest Cyclical Outlook, which summarizes the conclusions from PIMCO’s quarterly Cyclical Forum held earlier this month. If you haven’t read the outlook, you may wonder: “The beginning of the end of … what?” Here are three variations of the question, along with our answers.

The beginning of the end of … extreme monetary accommodation?

Yes, at least in the U.S. Consider what happened at the March Federal Open Market Committee (FOMC) meeting:

  • First, the Fed raised the target range for the federal funds rate to 1.5% to 1.75%, the sixth rate hike in this cycle. With core PCE inflation (the Fed’s preferred measure) at 1.5%, this means the real policy rate is now no longer negative. If, like me, you believe that that the neutral real policy rate (r*) is currently around zero, the Fed’s policy stance is no longer accommodative.
  • Second, the median FOMC participant now expects seven more rate hikes of 25 basis points to 3.4% by the end of 2020, adding two more hikes compared to the December 2017 dot plot, and taking the fed funds rate some 50 basis points above the Fed’s own estimate of the long-run neutral policy rate in three years’ time (See Tiffany Wilding’s take on the FOMC decision on the PIMCO blog). So the Fed now officially expects to overshoot neutral. Let this sink in.
  • Third, recall that the Fed is running down its balance sheet at an accelerating pace this year, which is worth about one additional rate hike.

As I see it, the end of easy money in the U.S. implies that the days of suppressed volatility in financial markets are coming to an end. With the dampened blanket of excess liquidity finally being withdrawn, beware of what lies beneath…