PIMCO's outlook for next year is based on "Five guiding principles and three difficult transitions"
- 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? A
- nd 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
Five guiding principles:
- 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.
- While markets are romancing a "New Paradigm" of permanently higher U.S. growth, inflation and equilibrium interest rates, we believe that our secular New Normal / New Neutral theme remains intact, at least for now ... However, there were several dissenting voices arguing forcefully in favor of a "New Paradigm"
- Even though it is likely that The New Neutral will remain intact, we have to be alert to cyclical over- and undershoots versus that secular baseline
- Not only the secular but now also the cyclical outlook in the new political environment is characterized by very high uncertainty, or "Radical Uncertainty"
- The path for the economy and markets will likely be determined by how three difficult transitions will play out on the cyclical horizon:
- The transition from monetary to fiscal policy
- The transition from globalization to de-globalization
- China's currency regime transition from what was a U.S. dollar peg until August 2015 to the current quasi basket peg to what may become a managed or even free float of the yuan.