The spread of COVID 19, volatile financial markets, new historical lows for U.S. bond yields, and a rare intermeeting rate cut by the Federal Reserve made for a highly unusual backdrop for PIMCO's quarterly Cyclical Forum in early March.
With uncertainty about whether and when the spread of the coronavirus can be contained, risks and disruptions to human lives now in many nations, central banks and governments in motion, and markets volatile, our discussions in the Investment Committee and in our regional portfolio committees will continue in the coming days and weeks. As usual, we plan to publish our quarterly Cyclical Outlook later this month.
However, because so much has changed since we published our last Cyclical Outlook in early January, here is an interim update of our macro views based on discussions to date.
New Neutral 2.0?
For starters, the rapidly deteriorating economic outlook, the recent sell-off in risk assets, and the rally in rates in response to the spread of the coronavirus serve to underscore our secular "Dealing With Disruption" theme and reinforce our long-standing New Neutral framework of very low ranges for risk-free rates. In fact, we may have entered the New Neutral 2.0, where secular disruptors such as the U.S.-China conflict, populism, technology, and demographics interact with black swans like the coronavirus outbreak to increase the demand for safe assets, thereby pushing the neutral rate of interest, plus the entire term structure of market rates, lower and lower.
Turning to the cyclical outlook, the global economy is now back in the "Window of Weakness" (the title of our September 2019 Cyclical Outlook) - which it was about to exit just when the virus hit. In our view, the worst for the economy is still to come over the next several months.
First, China's recent manufacturing and demand slump will likely affect activity in the rest of the world with a time lag of several months. Second, demand for services (travel, tourism, trade fairs, entertainment, meals away from home) will almost certainly continue to contract due to containment measures and the fear factor.
Against this backdrop, our current baseline, which assumes that the spread of the virus outside China will peak in the next few months, foresees a U-shaped trajectory for global growth over the next few quarters. However, this "U" may feel initially like an "I" as economic growth drops sharply, then like an "L" as the economy finds a bottom but visibility remains low for some time, before growth inflects higher and the upward turn in the "U" materializes.
Mr. Fels is a managing director and global economic advisor based in the Newport Beach office. He is a member of the Investment Committee and leads PIMCO's quarterly Cyclical as well as the Secular Forum process. Prior to joining PIMCO in 2015, he was global chief economist at Morgan Stanley in London. Previously he was an international economist at Goldman Sachs and a research associate at the Kiel Institute for the World Economy. He has 32 years of macro research experience and holds a diploma in international studies from the Johns Hopkins University School of Advanced International Studies in Bologna, Italy; a master's degree in economics from Universität des Saarlandes in Saarbrücken, Germany; and an undergraduate degree from Christian-Albrechts-Universität in Kiel, Germany.