Doug Allison, CFA and Beacon Pointe Advisors Senior Managing Director, and Jonathan Acosta, Vice President, recently sat down with PIMCO investment professionals to discuss specific issues that may have an impact on the global economy over the cyclical horizon (i.e., the next one to three years). On the heels of a strong U.S. equity market in 2013, the First Quarter of 2014 was compelling proof that global events can and do have a significant impact on the U.S. financial markets. The following interview provides PIMCO’s thoughts on the short-term outlooks for the economies of the U.S., Europe, China and Japan. Please keep in mind that the thoughts shared in this outlook are those of PIMCO and not necessarily those of Beacon Pointe Advisors.
PIMCO’s Global Economic Outlook Is Generally Optimistic, but Diverging Trends Are Increasingly Evident
PIMCO has increased its expectations for growth in the U.S. and Europe as cyclical dynamics become self-reinforcing. However, we have lowered our expectations in Japan and China, recognizing that both economic and policy uncertainty will likely rise. Emerging markets will steadily become more divergent as domestic issues take the fore. While inflationary pressures may slowly build across the globe, most developed market central banks will welcome the change and resist normalizing policy rates.
: What factors do you expect will drive growth in the U.S.?
: Our baseline expectation is for 2.5% to 3% real growth in the U.S. this year, due to positive trends in the consumer, corporate and public sectors.
Consumer spending will be the main driver as the wealth effect finally gains traction. With steady labor market improvement and a restoration of net worth – from equity markets and home values – we expect more confident consumers to use credit to lift the pace of spending. Corporations, which have record levels of liquidity, may finally increase their capital spending. Also important to our outlook is the removal of fiscal drag, as the need for budgetary restraint and the resulting Congressional squabbling have been markedly reduced. And net exports continue to improve as the U.S. steadily reduces its reliance on imported oil and gas.
One risk to the outlook is the poor quality of job creation, which could slow the growth of residential investment and home prices by delaying the rate of household formations. Another risk is the pace of business investment. While we expect a self-reinforcing trend to emerge as a more robust consumer encourages Corporate America to invest, the speed of this recovery has thus far disappointed.
: What does PIMCO expect from the Federal Reserve? When will the Fed begin to raise rates?
: While the Fed has begun tapering its asset purchase program, it has emphasized there will be considerable time between the end of asset purchases and the first hike in the policy rate, given persistently low inflation and slow growth. While we do expect inflation to begin to show signs of life this year with the Consumer Price Index (CPI) rising to 2.0%, the Personal Consumption Expenditures index (PCE), however, is likely to remain below the Fed’s 2.0% target, in our view.
: What is your outlook for a continuing recovery in Europe?
: We expect a modest pace of growth in Europe overall, with risks in both directions. The eurozone recovery remains fragile, but the European approach to crisis management of “muddling through” finally appears to have worked. Growth has returned to positive territory, the weak peripheral nations have corrected much of their imbalances, and capital market access has been restored – with yields at more favorable levels. Our baseline expectation is for real growth of 1% to 1.5% in the eurozone this year.
Less fiscal drag in the eurozone periphery should help credit conditions gradually improve. We expect global excess liquidity to move into eurozone assets amid increasing confidence in the ECB’s policy framework. Rising asset valuations should drive the positive feedback loop forward, steadying the outlook for consumer and corporate spending.
The downside risks to eurozone growth include weakness in credit markets, ongoing fiscal consolidation and the possibility of an external growth shock that decreases demand for exports. In addition, we expect deflationary pressures to continue and that the ECB may be forced to take action – likely in the form of asset purchases.
: What do you expect for Japan? Will it be able to sustain growth?
: Growth will surely moderate in Japan. Reduced fiscal stimulus, through both less growth in spending and higher tax rates, will drive the economy to contribute much less to global aggregate demand this year. We are expecting growth of just 0.5% to 1% in 2014, compared with about 3% in 2013. While Abenomics has successfully broken the deflationary psychology embedded in society, the outlook for real wage gains – crucial for sustainable growth and a healthy level of inflation – remains highly uncertain.
: Will China’s economy experience a “hard landing?”
: Growth in China will continue to decelerate, and the downside risks will likely outweigh the upside. Still, we believe the risk of a hard landing remains low. Our expectation is for growth of 6.5% to 7.5% this year, reflecting rising uncertainty.
Chinese authorities face a growing list of challenges associated with transitioning to a more sustainable growth model and an increasingly complex set of domestic policy levers. In the near term, reining in the shadow banking system and gradually restoring efficient and more market-based banking and credit models will be important. We remain fairly confident that the government maintains both the willingness to control the deleveraging process and the resources to recapitalize as necessary to avoid major disruptions. But as is evident in the recent sharp move in the yuan, the potential for a policy mistake will rise as the government gradually loses its grip on an increasingly large and complex economy.
Important Disclosure: This content is for informational purposes only. Opinions expressed herein are subject to change without notice. Beacon Pointe has exercised all reasonable professional care in preparing this information. Some information may have been obtained from third-party sources we believe to be reliable; however, Beacon Pointe has not independently verified, or attested to, the accuracy or authenticity of the information. Nothing contained herein should be construed or relied upon as investment, legal or tax advice. Only private legal counsel may recommend the application of this general information to any particular situation or prepare an instrument chosen to implement the design discussed herein. An investor should consult with their financial professional before making any investment decisions.
© Beacon Pointe Advisors. All Rights Reserved.