Fund manager projects Federal Reserve will cut interest rates more slowly than other central banks.
Bond fund giant Pimco is holding a smaller than usual position in US Treasuries and prefers the bonds of countries such as the UK and Canada, as it believes inflationary pressures may lead the Federal Reserve to cut interest rates more slowly than other major central banks.
Andrew Balls, chief investment officer for global fixed income at the $1.9tn-in-assets firm, told the Financial Times that weaker economic growth in some countries is helping ease price pressures there faster than in the US.
“Outside of the US . . . we are seeing more evidence of inflation correcting,” he said. “I think you see the balance of risks on the Fed going slower [in cutting rates] than is priced in but outside the US there is some risk of central banks delivering more than is priced in.”
Balls prefers longer-dated government bonds — which are more sensitive to changes in interest rates — outside of the US, and holds a smaller position than the benchmark index in the US. Markets currently anticipate three 0.25 percentage point cuts by the Fed and Bank of England this year, while for the European Central Bank it is closer to four.
US inflation has come in above analysts’ forecasts in January and February this year. Last week, Fed chair Jay Powell played down the recent uptick as the US central bank stuck to its forecast of 0.75 percentage points of interest rate cuts this year.
Powell also suggested it was too soon to know whether recent signs of stickier than expected inflation, especially in the services sector, would last. But he said he did not think recent readings had “really changed the overall story” of price pressures easing to 2 per cent.
Balls said that while his baseline expectations for inflation and Fed rate cuts were similar to market consensus, he sees “the risks towards stronger activity and sticky inflation.
“You have an ongoing US exceptionalism theme,” he added.
He also warned that the US’s yawning budget deficit — which the Congressional Budget Office estimates will rise by almost two-thirds over the next decade to $2.6tn — would be likely to push up long-dated Treasury yields, reflecting a fall in prices.
Ten-year US borrowing costs have risen to 4.2 per cent from 3.9 per cent at the start of the year, but remain far below a peak of more than 5 per cent reached last October when markets were worried about bigger than expected government borrowing plans.
“You can imagine that happening again,” Balls said, referring to the rise in yields last autumn.
“Both the Democrats and the Republicans seem unconcerned about the level of the fiscal deficit . . . It does seem likely that without having something exciting happening [like the UK’s 2022 gilts crisis] you could have a slow grind to higher term premia.”
Balls said his preferred places to have exposure to bonds more sensitive to changes in interest rates were in the UK, Australia, New Zealand and Canada. In December the FT reported that Pimco’s chief investment officer believed the UK was at risk of a serious economic downturn and that he had been running larger than usual bets on gilts.
Last week the Bank of England kept rates at 5.25 per cent for a fifth consecutive meeting, as widely expected. However, in a surprise to markets, the two most hawkish rate-setters on the monetary policy committee fell in line with the majority and voted to keep rates on hold, while one member voted for a cut.
BoE governor Andrew Bailey told the FT last week that markets are right to expect more than one rate cut this year and he is increasingly confident inflation is heading towards target.
Balls said his funds have a larger than normal position in gilts and he is not worried about a potential borrowing splurge ahead of a general election. In contrast, in 2019 he warned that a post-election borrowing binge promised by all major political parties could add to pressure on prices.
“I think both sides will have very similar fiscal policy and in the post [former prime minister] Liz Truss environment we tend to expect the UK to be very orthodox in terms of fiscal policy,” he said, referring to the 2022 gilts crisis triggered by an announced £45bn of unfunded tax cuts.
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