With her speech entitled “From Adding Accommodation to Scaling It Back” on 3 March 2017, U.S. Federal Reserve Chair Janet Yellen not only cemented market expectations for the Fed’s third rate hike in this cycle, subsequently implemented in the Ides of March. She also unintentionally provided what turned out to be the leitmotif of PIMCO’s March 2017 Cyclical Forum – scaling it back. We found ourselves applying the concept to not just the monetary policy outlook but to a range of developments across the global economy.
Aided by the participation of our Global Advisory Board consisting of its
chairman Ben Bernanke, Gordon Brown, Ng Kok Song, Anne-Marie Slaughter and
Jean-Claude Trichet, and informed by our macro team’s scenario analysis and
our regional portfolio committees’ presentations, PIMCO’s investment
professionals debated whether our 2017 cyclical (six- to 12-month)
narrative of radical uncertainty and fatter tails from last December (see “Into the Unknown”) was still intact. Our conclusion: Yes, but.
Given the continuing lack of detail on the Trump administration’s fiscal
and trade policies, the lingering uncertainty about the upcoming elections
in France, Germany and potentially Italy, and the risks associated with
China’s debt bubble and capital outflow pressures, we reconfirmed our “Stable But Not Secure” secular (three- to five-year) framework and generally also our “fatter
tails” cyclical outlook. (“Fatter tails” refers to the distribution curve
of potential outcomes in which we see a generally lower-than-usual
probability of the central or baseline scenario coming to pass and
correspondingly higher probabilities of the tail-risk scenarios, both to
the downside, or left tail, and to the upside, or right tail.) However,
given what we learned in the three months since our December forum,
our cyclical story has become slightly more nuanced in several ways. Here’s how and why:
we scaled back the expected size of fiscal stimulus in the U.S.
and now anticipate a fiscal package to be finalized in Congress only in
early 2018 – thus its impact would occur beyond our cyclical horizon.
Repealing and replacing Obamacare will keep Congress busy for a while, and
comprehensive tax reform will take time and is hard to do given the rising
opposition to the border adjustment tax from the adversely affected
importing industries and in the Senate. Thus, any fiscal boost is likely to
be smaller and come later. Viewed in isolation, this somewhat reduces the
probability of a right-tail (positive) outcome for economic growth, at
least over our cyclical horizon, even though expectations of an eventual
fiscal package should continue to support consumer and business sentiment.
Second, it also seems appropriate to scale back the left-tail risk of a full-blown trade war
sparked by aggressive U.S. trade policy changes. To be sure, the rhetoric
coming out of the administration on trade continues to be antagonistic.
However, the reported debate within the White House between moderate
“globalists” and more aggressive “nationalists” suggests that the rhetoric
shouldn’t be taken at face value. It would have been easy for the Trump
administration to impose trade sanctions early on via executive orders. The
fact that this hasn’t happened even though the trade hawks were already
operating in the White House early on in this administration while the more
moderate voices were still awaiting congressional confirmation suggests