Bond giant Pimco made a case for owning high-quality U.S. bonds yielding about 5%-8% rather than stocks on Wednesday, in part because they should offer downside protection if the U.S. economy falters over the next six to 12 months.
“We believe growth and inflation have peaked, and we see greater recession risk than markets are pricing in, which supports a positive outlook for fixed income returns,” a Pimco team wrote in a outlook Wednesday.
The report, written by Nicola Mai, sovereign credit analyst, Tiffany Wilding, economist, and Andrew Balls, chief investment officer of global fixed-income, warned that an economic “soft landing” would be an “anomaly,” given that almost all instances when central banks hiked rates by more than 400 basis points since the 1960s resulted in recession.
The Federal Reserve has raised its policy interest rate to a 22-year high in a range of 5.25% to 5.5%, and warned in September that rates could stay higher than earlier anticipated to keep inflation heading lower to its 2% yearly target.
The tough talk sparked a jolt higher in longer-term Treasury yields, with the 30-year
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rate briefly touching 5% and the 10-year yield
BX:TMUBMUSD10Y
setting fresh highs in 2023.
U.S. bond yields have since pulled back at bit, aiding the Dow Jones Industrial Average
DJIA
and S&P 500 index
SPX
in a recent three-day rally, which looked in jeopardy on Wednesday.
Related: What surging 10-year rates mean for your next car loan, mortgage or student loan
Fed minutes of the September meeting showed that officials were “highly uncertain” about the U.S. economy‘s future path, and a careful approach to interest-rate policy.
The Pimco team said cash can also be attractive, given that short-term yields
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are high relative to history, offer flexibility and liquidity, but they also that “cash yields are fleeting.”
They expect longer-duration bonds to provide greater resilience in portfolios, since they lock-in yields over a longer time horizon and can potentially appreciate in a recession.
However, Pimco, which oversees about $1.8 trillion in assets, remains cautious about corporate credit, including floating-rate corporate debt that includes bank loans and some legacy private credit, “where we are already beginning to see the strain from higher rates.”
Related: A wrecking ball could hit leveraged loans if the Fed keeps rates high
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