January Jitters – PIMCO’s Global Update

PIMCO’s Global Update delivers a brief but comprehensive review of the month’s market-moving events – across countries and asset classes – and PIMCO’s thoughts on what to expect going forward. Below is an extract from this document, the complete document can be accessed here.

A rough start to 2016 highlighted just how addicted investors have become to easy money. Volatility in Chinese equities, a faster-than-expected depreciation in the yuan and a collapse in oil prices all contributed to fears that tighter policy from the U.S. Federal Reserve (Fed) may be about to push the global economy into a recession.

PIMCO expects the world’s major economies to continue converging in 2016 while central bank policies diverge. The U.S. recovery will remain on a fairly stable trajectory. Growth in Europe and Japan is projected to increase only modestly, while BRIM (Brazil, Russia, India, Mexico) economies should see gradual improvement. The Fed will maintain its bias toward raising rates, but most other central banks will likely ease policy through rate cuts or quantitative easing (QE), or at least keep rates on hold.

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In the U.S., our baseline expectation is for slightly above-trend economic growth of 2.0%–2.5% over the year with underlying inflation of 1.5%–2.0%. With job growth expected to slow as the economy reaches full employment, personal spending will be tied more closely to real wages, which should improve modestly. Given soft global demand and a strong U.S. dollar, we anticipate little boost from international trade. On the positive side, the recent budget agreement will provide the U.S. economy with a modest fiscal boost. We see the risks biased toward more Fed rate hikes than the market expects. At the end of January, the market was pricing in slightly less than a quarter-point increase at most.

For the eurozone, we anticipate above-trend GDP growth of about 1.5%. The ECB’s continued QE measures will keep bank lending rates low across both core and peripheral countries, boosting loan growth. While net exports should benefit from the euro weakening to date, slower growth in the eurozone’s major trading partners may limit their contribution to growth. Headline inflation will depend on the path of oil prices and the euro, but core inflation is likely to remain below the ECB’s definition of price stability. Persistently below-target inflation should open the door to expansion of the existing QE program.

Japanese GDP growth should increase modestly to about 1% in 2016. A weak yen may continue to support corporate profits and the stock market, but the slowdown in China and other trading partners will remain a headwind to net exports. Headline inflation could advance toward 1%, but will likely remain below the BOJ’s target of 2%. Amid concern that the quantitative and qualitative easing (QQE) program could run up against technical limits, the BOJ introduced negative interest rates in late January, but the implications for inflation and growth remain unclear. Japan’s shift in fiscal policy goals –an important new development – could be supportive of stronger growth.

Our outlook for China is little changed with expectations for growth around 6% and headline inflation about 2%. We still believe China possesses the “will and the wallet” to deal with the challenges of slower growth and pivot toward a service economy; however, the task is difficult and policy mistakes may occur along the way. We anticipate additional easing via cuts to the deposit rate and required reserve ratio. We also see a modest rise in the budget deficit due to quasi-fiscal financing of local public works.

We expect BRIM growth to increase modestly to 1.25%–2.25%. An important driver of our lower-than-consensus forecast is the extended contraction in Brazil, given the sharp drop in confidence and elevated political uncertainty. Russia is also expected to contract in 2016, albeit at a slower pace than previously. Meanwhile, both India and Mexico should grow in line with consensus. We forecast 2016 headline CPI inflation in BRIM at 6% (consensus at 5.9%), but Brazil remains the outlier with higher-than-consensus inflation.

To access PIMCO’s complete Global Update and talking points for your clients click here.

Disclosures

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