Scott Mather, CIO U.S. Core Strategies and a managing director at Pimco, thinks that monetary policy normalization will be a game changer for financial and expects the return of volatility. Interview with Christoph Gisiger, Finanz und Wirtschaft reposted in part with permission
The bond market is on the move. The economy is gaining steam and interest rates are rising. This week, the yield on ten year Treasuries climbed to the highest level since the summer of 2014. Despite that, Wall Street doesn’t’ seem to care much. The Dow Jones (Dow Jones 26098.07 -1.29%) chases record after record and investors take on more and more risk.
«So far, they have been rewarded. But it’s dangerous», says Scott Mather. The veteran Chief Investment Officer of U.S. core strategies and managing director at the Californian bond giant Pimco expects that inflation will become a key topic this year. He cautions that the global normalization of monetary policy is going to be a game changer and volatility will finally stage a comeback.
Mr. Mather, bond yields are rising. It this a sign that the economy is getting better?
I think this year is going to be the best year in terms of growth that we have seen in a while. For the first time in a long time, there’s not one major region in the world that is underperforming. The outlook for Europe looks pretty good. In the US, we are going to get fiscal spending which is going to bump up growth to probably 2,5% with risk to the upside. That’s versus 2% for many years in the past. Japan’s growth looks pretty good, too. Also (ALSN 139.4 -1.13%), in the emerging markets almost all the problem cases have recovered. Putting it all together that means you have to bump up your growth forecast for the world by a quarter to half of a percentage point versus what people were thinking a year ago.
That’s sounds encouraging. How sustainably it this pick up in US?
We have some concerns that the US is going to slow back down again because much of the growth this year is fiscal stimulus. There’s the corporate tax cut which is structured to pull the activity forward: The incentive for corporations is to do all the spending and investment this year and then push the profits out to the future when they’re taxed a lower rate. So investment spending could bump up this year because of that. You also have another $100 billion of fiscal spending from the hurricane relief and raise in defense spending. But that’s just kind of a onetime shot because it won’t be repeated the following year. Also, we’re pretty close to full employment. At some point, if you can’t put more and more people into the labor force you are going to slow down unless they become more productive and there is no reason to think that we are going to see some productivity miracle. So after the boost this year there will be some sort of a gravitation that will us pull back down.
How does filter into your outlook on inflation?
Inflation is a factor that will come into play this year. It’s sort of unique that we haven’t had wages rebound and inflation come back sooner. But we don’t think the laws of supply and demand have been repealed. If we start to see wage inflation, that’s sort of an omen for future generalized inflation and we know that the Fed pays a lot of attention to wages. So inflation will probably head closer to the Fed’s 2%-target which means the Fed will have reason to move. It’s not as if they want to slow the economy down. But they have reason to move to try to at least get back to a neutral Federal Funds Rate. And if we get a little bit of acceleration in terms of inflation as we head through the year they will probably even think about what they should be doing with respect to overshooting. Having inflation overshoot a little bit might be ok. But they could start to get nervous.
What does this mean with respect to monetary policy?
We are getting into an environment where monetary policy around the world starts to reverse course. I think that’s one of the big themes this year which is a global movement towards normalization. In US, we will get two or three more rate hikes this year. That takes the Fed Funds Rate back in the 2% to 2,5% range and that’s the level that starts to slow the economy down. At the same time, the ECB tapers and will be done with QE by the end of the year. Elsewhere, it looks like that the Bank of England will hike once this year. The Bank of Japan is likely to tweak its balance sheet expansion and yield curve control. The Bank of Canada has moved, and the Reserve Bank of Australia will probably be moving this year as well. So everybody starts moving.
Right now, everybody is focusing on the ECB. Will the European Central Bank be able to follow through with its plans to normalize monetary policy?
Growth in Europe has been good which has surprised them. I think we have seen the lows in inflation. So there is reason for the ECB to think the same way the Fed has which is to take advantage when you have the opportunity to start normalizing. The big priority would be getting away from negative rates. If that goes well, then they will make a judgment if they want to shrink the balance sheet first or hike rates. Probably they want to hike rates a bit further. So it’s the same playbook as the Fed and we think that economic growth will allow for this.
It’s been almost four years since the ECB became the first major central bank to push rates to negative territory. Are they at risk of falling behind the curve?
If the ECB could do it over, they probably would be tapering faster because growth has surprised them. If you’re a Martian and you landed on earth you would be like: “What in the world are these central banks doing?”
Read the full article by Christoph Gisiger, Finanz und Wirtschaft