PIMCO’s baseline outlook for the cyclical horizon has the global economy continuing its uneven recovery before shifting to a more moderate pace of above-trend growth in 2022. And although inflation is spiking, particularly in the U.S., we continue to view the factors driving the recent price surge as transitory. Nonetheless, heightened macro volatility can translate into heightened market volatility. As investors, we believe it’s important to maintain portfolio liquidity and flexibility so we can respond to and take advantage of these developments.
Despite low yields, bonds can continue to diversify risk in broad portfolios, and active management offers the opportunity to capture additional return over government bond yields. In terms of positioning, on interest rates we expect to stay close to home, emphasizing relative value country positioning and positioning on the yield curve to generate income. In spread sectors, we still find opportunity in specific sectors and through active security selection. Currently we favour allocations to non-agency U.S. mortgages and other asset-backed securities, as a key component of the risk positioning.
On corporate credit, while we see little potential for significant spread tightening, there is also likely to be strong ongoing demand for credit, given low government yields. A decline in hedging costs for foreign investors could continue to provide support for U.S. credit. We continue to favour security selection with a focus on financials, cyclicals, housing-related sectors, and COVID-19 recovery trades. Importantly in this environment we think it pays to be cautious and we favour quality. We emphasize the importance of building diversified portfolios that take advantage of attractive parts of the ~$120tn fixed income opportunity set. The breadth of this opportunity set not only provides us with the potential to generate attractive returns, but also enables us to reduce portfolio risk through greater diversification.