PIMCO, the world’s largest bond fund, is expecting growth in the U.S. economy in 2014.
PIMCO’s recently released cyclical outlook for the Americas is forecasting growth in the U.S. economy of 2.5-3% in 2014.
“The main source of the improvement in outlook comes from a reduction in fiscal drag,” PIMCO Portfolio Manager Mohit Mittal said. “Recall that in 2013, we saw significant fiscal drag from the payroll tax hike, Affordable Care Act taxes and sequestration. The incremental drag from these measures will decline in 2014. Additionally, public sector revenues have improved, helped by higher asset prices and improvement in consumption. As a result, the fiscal deficit will decline to around 3.5% of GDP in 2014, which is near the long-term average, thereby eliminating the need for additional fiscal restraint on the economy.”
PIMCO also expects to see improvement in consumption driven by consumer optimism, easing credit conditions and steady job growth.
PIMCO identifies one factor as the main stumbling block that could inhibit the projected growth in 2014. “We think the biggest risk to the U.S. outlook comes from the ongoing tapering,” Mittall said. “During the last four years, whenever the Fed has tried to end quantitative easing, we have seen growth begin to falter. The end of QE can lead to higher interest rates that can hurt many of the rate-sensitive sectors of the economy like housing, auto lending and other forms of credit.”
Just two weeks ago, the market reacted poorly when Federal Reserve Chair Janet Yellen said that there could be a six-month gap before rate hikes after bond buying ends.
PIMCO offers investors this advice in the face of the Yellen-influenced reactive market. “The odds of the U.S. economy maintaining another year of tranquility have increased,” Mittal said. “But the Fed must convince markets of its credibility as it exits QE. If it succeeds, risk assets should do well. However, investors should also recognize that valuations in most asset classes have risen given ongoing global QEs. In duration, investors should focus on short maturity U.S. rates instead of longer maturity rates, given the improving economic trajectory and the risk of the Fed raising rates around mid-2015. Similarly on the credit side, short maturity credit and credit sectors tied to the housing and consumer recovery offer value, provided companies are using that growth to de-lever instead of re-lever.
“Finally, because liquidity will likely deteriorate as the Fed tapers and banks implement new regulatory requirements (for example, the supplementary leverage ratio and the liquidity coverage ratio), investors should focus on maintaining a high degree of liquidity.”