Pimco has pared its positions in government debt on fears that a breakthrough in US-China trade talks could trigger a violent sell-off, which would put an end to one of the biggest fixed income rallies in history.
The Bloomberg Barclays Multiverse index — the broadest bond market gauge that tracks debt with a market value of more than $59tn — has returned more than 7 per cent already in 2019. If the rally continues at the same pace, this year will be the best for the gauge since 2003.
Although Pimco remains confident that bond yields will remain relatively low — and could still plumb new depths — the sheer power of the rally over the summer means that the balance of risks has now shifted, according to Dan Ivascyn, group chief investment officer at the giant investment house.
“We’re a lot more defensive,” Mr Ivascyn said in an interview. “Even if we get a narrow trade agreement [between the US and China] we could see a pretty powerful snapback in yields.”
Several big Pimco funds controlled by its investment chief, including the $128bn Pimco Income Fund, have therefore been lightening up on their positions in the UK, European and — to a lesser extent — the US government bond markets. But even in the US, Mr Ivascyn noted, there are chances of a sell-off if inflation data come in stronger than expected, prompting the Federal Reserve to stay on hold.
“We like the US market more — it still has more room to rally in a global flight to safety,” Mr Ivascyn said. “But it wouldn’t take much of an uptick in inflation to cause a meaningful repricing.”
Money pouring into fixed-income funds has pushed the yields on over $16tn of bonds below zero, while cutting the average yield of the Multiverse bonds close to an all-time low of 1.4 per cent. Many investors are convinced that yields will continue to sag lower, as the Federal Reserve is forced to unwind its interest rate increases and the European Central Bank readies another round of monetary stimulus.
Mr Ivascyn’s flagship fund is the top performing bond fund in its category tracked by Morningstar over the past decade, but the cautious stance on the government bond rally has weighed on its performance this year. The Pimco Income Fund has gained 4.4 per cent so far in 2019, putting it in the 94th percentile of similar funds tracked by Morningstar.
“Expensive things can certainly get more expensive,” Mr Ivascyn conceded, noting that the prospects of a complete truce in the trade war seem remote. “We think we’ll at best get a partial agreement on trade, and this friction will be with us for a long time.”
The big question for investors is what could be a catalyst for a reversal of the bond market rally. For example, markets have shrugged off a run of solid US data — including strong retail sales and faster inflation — because they remain convinced that growth is slowing and rate cuts are imminent.
However, a handful of former central bankers working for BlackRock, the world’s biggest asset manager, last week highlighted one scenario that would force bond yields higher.
A report co-authored by Philipp Hildebrand, Stanley Fischer and Jean Boivin pointed out that central banks have limited firepower left in their monetary armoury, and that fiscal policy is constrained by still-high debt levels. The trio concluded that “unprecedented policies will be needed to respond to the next economic downturn”.
The report added: “Without a clear framework in place, policymakers will inevitably find themselves blurring the boundaries between fiscal and monetary policies …This threatens the hard-won credibility of policy institutions and could open the door to uncontrolled fiscal spending.”
This is something that is starting to play on the minds of some investors, such as Pimco. “We could still see more unorthodox policies, like ‘helicopter money’,” Mr Ivascyn said, alluding to central-bank financing of additional government spending.
“We think it’s premature to declare inflation to be dead.”
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