Pimco’s Clarida expects a ‘modest’ recession in the US
The Fed is expected to begin to cut rates in the first half of next year; high-quality fixed income yields attractive
Genevieve Cua
PIMCO global economic adviser Richard Clarida says the US economy is likely to experience a “modest’’ recession, even as he expects two more interest rate hikes this year.
Dr Clarida, former vice-chairman of the board of governors of the US Federal Reserve System, believes the Fed will hike rates – once in the upcoming meeting this week and a second time possibly in November or December.
“From the Fed’s institutional perspective, they want to avoid a situation where they pause and in effect declare a victory (on inflation) too early, and then have to start re-hiking rates.’’
Inflation in the US slowed to 3 per cent in June, from 4 per cent in May. While the Fed in June had indicated the likelihood of two rate hikes this year, the drop in inflation has prompted some economists to forecast just one hike in July.
In an update last week, Pimco economist and managing director Tiffany Wilding wrote that July may be the last hike of the cycle. “Lagging wages will likely keep pressure on the Fed to maintain a restrictive policy until the US economy has entered recession. The good news (is that) this fall in price inflation could very well thwart additional rate hikes (after the July meeting, when we think Fed officials will announce their last rate hike of this cycle).
“However, we aren’t convinced that material slowing (and mild recession) can be avoided, and we don’t expect central bank policy rate normalisation to start until the unemployment rate starts to tick up.’’
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Dr Clarida said: “We’re in the camp of what we call the ‘soft-ish’ landing. GDP growth slows… unemployment rate rises by about a percentage point or so. And inflation comes down into the (2 per cent range). We would consider that a pretty good outcome.
“We think avoiding a recession will be unlikely but a soft landing is certainly possible.’’
He expects the Fed to begin cutting interest rates only in the first half of 2024. “The hurdle to cut rates this year is high … I think the Fed chair deserves credit for holding the committee together given that this is a pretty diverse committee. I’ve not seen anyone in public endorse the view that the committee could hike rates as aggressively as they have, and then quickly turn around and start to cut.
“If the economy does downshift, if inflation does fall into the 2-plus per cent range, we could see them start to cut rates in the first half of next year.’’
Dr Clarida said investment-grade fixed income assets are attractive now, and the 60/40 portfolio (60 per cent stocks, 40 per cent bonds) “will continue to make sense’’.
“Research has shown that historically the best single predictor of total return on a fixed income investment is the starting coupon or yield. On that basis, high quality fixed income is at the most attractive levels we’ve seen in 15 years, especially if you look at yields in inflation-adjusted terms.
“If you believe as we do that the Fed and other central banks will succeed and return inflation down to their target, then the starting yields are actually quite attractive.
“Because the yield curve is inverted, front-end yields are above longer-duration yields. Investors can earn an equity-like return without even taking a lot of interest rate risk.’’
He added that there are also good opportunities in mortgage-backed securities and private credit. “Investors should want to have an allocation to fixed income in a diversified portfolio.’’
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