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Three Key Takeaways From PIMCO’s Cyclical Outlook: Flatlining at The New Neutral

Following the Federal Reserve’s pivot to patience, we believe U.S. short-term interest rates are now anchored in The New Neutral. Global growth keeps synching lower, but may experience a soft landing later this year if China’s economy stabilizes and trade tensions ease. However, political uncertainties suggest a cautious overall approach to investing. These are three key conclusions we discuss in detail in our latest Cyclical Outlook, “Flatlining at The New Neutral.”

Following the Federal Reserve’s pivot to patience, we believe U.S. short-term interest rates are now anchored in The New Neutral. Global growth keeps synching lower, but may experience a soft landing later this year if China’s economy stabilizes and trade tensions ease. However, political uncertainties suggest a cautious overall approach to investing.

These are three key conclusions we discuss in detail in our latest Cyclical Outlook, “Flatlining at The New Neutral.”

The Fed embraces The New Neutral and revisits policy strategy

The most consequential recent development for global markets was the Fed’s pivot from projecting further gradual rate increases to adopting a patient, wait-and-see attitude on rates and signaling an end to balance sheet runoff later this year.

In addition, the Fed has now acknowledged that the current policy rate (2.25% to 2.5%) may be at or close to neutral, in line with PIMCO’s long-standing view of a New Neutral range of 2%–3%. We expect the fed funds rate to broadly flatline at the current level for the foreseeable future.

The Fed also announced it is reviewing its monetary policy strategy later this year. We expect any changes in the Fed’s framework to be evolutionary rather than revolutionary, but we would expect the Fed not only to tolerate but to welcome a moderate inflation overshoot, should it occur.

Global cycle: China is the swing factor

The slowdown of global growth over the past year despite massive fiscal stimulus in the U.S. and still-supportive monetary policies in the advanced economies illustrates that, more than ever, China is a key driver of the global cycle. The Chinese government’s deleveraging campaign and the trade conflict with the U.S. contributed to a slump in global trade growth, which in turn dragged down business confidence and investment around the world.

So far, there are few signs that the global trade cycle has bottomed, and we see global growth still synching lower in the near term. However, we see a good chance that global growth will stabilize or even pick up moderately later this year. One reason for our cautious optimism is the easing of global financial conditions since the Fed’s dovish pivot. Another is that China has recently stepped up the pace  of fiscal and monetary easing, in effect “flooding” the entire system. These factors could enable a soft landing of sorts for the global economy – albeit with further air pockets along the flight path.

Risks: simmering trade conflicts and fiscal policy shifts

While markets have fully priced in a U.S.–China trade deal, they are probably underestimating the potential for trade flare-ups elsewhere. NAFTA’s replacement, the USMCA (U.S.–Mexico–Canada Agreement), faces significant challenges to pass Congress, and President Trump may decide to withdraw from NAFTA in order to increase pressure on Congress to pass the deal. In addition, the Trump administration may threaten or even go so far as to impose tariffs on auto and auto parts imports. Though a full-blown global trade war is unlikely, we expect trade tensions to continue to simmer, leading to occasional bouts of market volatility.

Fiscal policy is another source of uncertainty and potential volatility, with proposals in Europe and the U.S. to levy wealth taxes, increase marginal income and corporate tax rates, introduce universal basic income, and break up large tech companies. And while it is unlikely to become real policy in the foreseeable future, the recent prominence of Modern Monetary Theory (MMT) in the public debate is symptomatic of a broader paradigm shift toward a view that fiscal policy should become a more active tool to stimulate growth, counter the global savings glut, and address rising income and wealth inequality.

Investment implications

Financial markets have priced in the “synching lower” growth theme and central bank dovishness, but we continue to be concerned about longer-term recession risks, shifts in the balance between monetary and fiscal policy, trade tensions, and political populism. Therefore, we remain cautious in our overall macro positioning. We emphasize flexibility and liquidity, keeping powder dry to be put to use during periods of higher volatility.

Read PIMCO’s latest Cyclical Outlook, “Flatlining at The New Neutral,“ for further insights into the outlook for the global economy along with takeaways for investors.

READ HERE
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Joachim Fels

Global Economic Advisor

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London
PIMCO Europe Ltd
11 Baker Street
London W1U 3AH, England
+44 (0) 20 3640 1000

Dublin
PIMCO Europe GmbH Irish Branch,
PIMCO Global Advisors (Ireland)
Limited
3rd Floor, Harcourt Building 57B Harcourt Street
Dublin D02 F721, Ireland
+353 (0) 1592 2000

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PIMCO Europe GmbH
Seidlstraße 24-24a
80335 Munich, Germany
+49 (0) 89 26209 6000

Milan
PIMCO Europe GmbH - Italy
Corso Matteotti 8
20121 Milan, Italy
+39 02 9475 5400

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PIMCO (Schweiz) GmbH
Brandschenkestrasse 41
8002 Zurich, Switzerland
Tel: + 41 44 512 49 10

PIMCO Europe Ltd (Company No. 2604517) is authorised and regulated by the Financial Conduct Authority (12 Endeavour Square, London E20 1JN) in the UK. The services provided by PIMCO Europe Ltd are not available to retail investors, who should not rely on this communication but contact their financial adviser. PIMCO Europe GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Europe GmbH Italian Branch (Company No. 10005170963), PIMCO Europe GmbH Irish Branch (Company No. 909462), PIMCO Europe GmbH UK Branch (Company No. BR022803) and PIMCO Europe GmbH Spanish Branch (N.I.F. W2765338E) are authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 15 of the Securities Institutions Act (WplG). The Italian Branch, Irish Branch, UK Branch and Spanish Branch are additionally supervised by: (1) Italian Branch: the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act; (2) Irish Branch: the Central Bank of Ireland in accordance with Regulation 43 of the European Union (Markets in Financial Instruments) Regulations 2017, as amended; (3) UK Branch: the Financial Conduct Authority; and (4) Spanish Branch: the Comisión Nacional del Mercado de Valores (CNMV) in accordance with obligations stipulated in articles 168 and 203 to 224, as well as obligations contained in Tile V, Section I of the Law on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217/2008, respectively. The services provided by PIMCO Europe GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication.| PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2) . The services provided by PIMCO (Schweiz) GmbH are not available to retail investors, who should not rely on this communication but contact their financial adviser.

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Looking Beyond Market Stabilization to the Future Path of Monetary Policy
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