Investors and policymakers alike will have to come to grips with a radically different macro environment over the secular horizon as the post-financial-crisis, pre-pandemic New Normal decade of subpar-but-stable growth, below-target inflation, subdued volatility, and juicy asset returns is rapidly fading in the rear-view mirror.
What lies ahead is a more uncertain and uneven growth and inflation environment with plenty of pitfalls for policymakers. Amid disruption, division, and divergence, overall capital market returns will likely be lower and more volatile. But active investors capable of navigating the difficult terrain should find good alpha opportunities.
Initial conditions
As such, this year's secular thesis further develops the themes we highlighted in our 2020 Secular Outlook - Escalating Disruption. PIMCO argued then that the pandemic would serve as a catalyst for accelerating and amplifying four important secular disruptors: the China-U.S. rivalry, populism, technology, and climate change.
Developments over the past year have reinforced those expectations. China-U.S. tensions have not only continued but intensified under the Biden administration. Populism and polarization have been on the rise in many countries, further fuelled by politically charged divisions over lockdowns and vaccines.
Digitalization and automation have been turbocharged by the pandemic. Extreme weather conditions in many parts of the world have also inflicted severe human and economic losses and contributed to major gyrations in energy markets. In our forum discussions we concluded that each of these secular disruptors will remain active in the foreseeable future.
Another important initial condition for the secular outlook is the sharp further increase in public and private sector debt caused by the pandemic recession and the policy responses. To be sure, with borrowing costs at or close to record lows, record high debt levels are not an immediate concern. However, higher leverage implies heightened vulnerability of public and private sector balance sheets to negative growth shocks and to positive interest rate shocks, thus increasing the risk of destabilizing runs on sovereign and private borrowers.
Moreover, elevated debt levels and highly financialized economies as measured by wealth-to-income ratios will likely constrain central banks' ability to push interest rates aggressively higher without causing severe economic pain - a financial market dominance theme.
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This post was funded by PIMCO
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