PIMCO’s Dan Ivascyn spells out inflation risks

A so-called ‘head fake’ is one of the dangers posed by the trajectory of inflation in years ahead, says PIMCO’s Dan Ivascyn.

Dan Ivascyn, chief information officer of Pacific Investment Management Co. (PIMCO), has warned on looming inflation risks. Photographer: Kyle Grillot/Bloomberg

One of the biggest risks in equity markets is bond yields rising too significantly and too quickly, PIMCO chief investment officer Dan Ivascyn has warned.

The $2.2 trillion investment management firm is also watching for an inflation “head fake” that could roil markets later this year.

Inflationary pressures, meanwhile, will push Australia’s core CPI to a peak of 3 per cent, with the near-term risks skewed to the upside, Mr Ivascyn told the Morningstar Investment Conference on Thursday.

Likewise, inflation in the US would also peak around the 3 per cent mark, higher than PIMCO had initially anticipated.

But these pressures are transitory and butting against ongoing deflationary forces, which will see inflation taper off in later years, he predicted.

Despite having a “fairly constructive view” on the trajectory of inflation over the next couple of years, Mr Ivascyn warned of the risk of an inflation “head fake”, which he said could be “quite severe” later this year.

PIMCO sees the prospect of market volatility rising in the coming months due to the ‘head fake’ of investor fears of inflation risks rather than higher inflation itself.

“This is why we think it makes sense to be underweight interest rate exposure at this time,” he said.

“Despite a lot of the near-term concerns, you can still source this protection at a reasonable level. The same thinking applies to commodity markets and other areas where you can insulate your portfolio from these other tail inflationary-like scenarios.”

Over the short term, PIMCO sees three big inflation risks: the housing market, labour supply and inflation expectations.

On the housing side, the pressure would come from rents, Mr Ivascyn warned.

“When we look at the gap today between home prices, particularly in the US, versus rents, that gap is near the widest that it’s been historically. So this does bear watching. We’re in a situation now where across much of the world there are various moratoria in place in dealing with challenged renters or borrowers in the housing market.

“It will be very interesting to see what happens at the end of this year when those restrictions are lifted. Our base case is that rents are going to move higher.”

Another looming inflationary risk for PIMCO is labour supply. While Covid-19 pushed many workers out of the workforce, both in the US and most other regions in the world, PIMCO’S base case is that this labour supply pool will begin to now return to the workforce.

“If we don’t see some of this labour force begin to return over the next few months we’ll become a bit more negative in terms of the overall thinking around inflation as well,” Mr Ivascyn said.

The investment management firm is also closely watching inflation expectations.

“We’ve had multiple decades now of inflation surprising to the downside. This is the first case study we’re going to have around inflation expectations and the degree in which short-term inflationary pressures … begin to get embedded into longer-term inflationary expectations.

“We believe it will take a much more sustained period of inflationary pressures to drive these expectations higher but again this is somewhat untested and will be an area of focus, not only for PIMCO, but for central bank policymakers as well.”

PIMCO is less concerned with short-term inflationary pressures as seen in used car sales and semiconductor chips but Mr Ivascyn cautioned on the need to source inflation protection within fixed income markets.

Unlike others, the investment manager is also not so concerned about booming housing markets around the globe.

“One particular area of the market that we continue to like relates to housing-related investments.

“When you look at the housing market today and contrast it with the market 10 -15 years ago, you have a market that has been significantly impacted by post-global financial crisis regulation. These home prices are going up in an environment where credit extension remains quite rational.”

Other areas of the market the investment manager likes are emerging markets, less liquid private segments, and global banks.