Home / Cross-country allocations at forefront in the new neutral

(Pictured: Scott Mather)

Japan and Australia are countries to watch as the global economy heads towards a “new neutral” with real interest rates generally around zero. But opportunities for bond investors will occur as individual countries react differently to policy challenges.

Japan, in particular, has embarked on an “experiment” with both fiscal and monetary policy and Australia is looking to decouple from China as that economy continues to slow, according to the first in a new series of papers from PIMCO, the world’s largest bond manager.

While admitting that interest rates in the west will rise, PIMCO, which has the most to lose of any fund manager in such an environment, says they will not rise by as much as many people fear.

PIMCO’s new “Secular Outlook Series” is being written, in turn, by its six new deputy CIOs, who were appointed to their positions this year following the resignation of former CEO, Mohamed El-Erian, who was replaced internally by Doug Hodge. They report to CIO and founder Bill Gross. The first in the series, published last week, is by Scott Mather, deputy CIO and managing director for global bonds and emerging markets.

Mather says: “One of the most important places to watch is Japan. By pulling all the levers at once – monetary and fiscal policy along with a structural re-engineering of the economy – amid demographic changes and a massive debt overhang, Japan is embarking on a big experiment.

“Over the secular horizon, we think Japan’s economy is likely to have periods of instability, and our global forecast has the widest range of possible growth and inflation outcomes for Japan. We could see an overshoot from deflation into inflation, or growth could diminish if structural reform fails. Yet the experiment is a good thing; although there are likely to be some hiccups along the way, if Japan is successful, it could become a model for other advanced economies that are trying to grow their way out of debt, such as those in Europe and perhaps even the US.

“Australia is another economy to watch in the region, given its dependence on China as a buyer of its commodities. Like much of the world, Australia is attempting to re-engineer its economy toward domestic demand-driven growth.”

While expecting “normalization” of interest rates in many countries at near zero, PIMCO believes that currency and interest rate volatility will also settle into a new lower range.

Mather says: “There will be secular trends that represent opportunity in the context of lower volatility (for instance, generalized US dollar strength and weakness in the Japanese yen over our secular horizon). And emerging markets may see reduced volatility relative to history, but attractive overshoots will occur throughout the normalization process.”