What’s the best defense against rising rates? PIMCO’s Jim Moore argues there are benefits to active investing.
“Once the Fed rate hike cycle begins, the yield curve will not necessarily move uniformly and line up with what the Fed does at the front end,” says Moore, who is a managing director and head of PIMCO’s investment solutions group, in a commentary from PIMCO. “An active manager can pick spots on the yield curve where the risk/return characteristics are more favorable as opposed to simply replicating the allocations of an index.”
Active management also has its benefits in a rising rate environment from a global perspective, according to Moore.
Since many areas around the world are in easing cycles, Moore argues this can benefit both the U.S. and active managers.
“Europe is behind the curve relative to the U.S. with slower growth and lower inflation, Japan is committed to easing to try to keep the economy growing, China is easing given the slowdown there, and some emerging market countries are easing as growth slows in response to the Fed and the slowdown in demand from China for their exports,” Moore says. “Active managers can take account of non-U.S. bonds as offshore rates are either stagnant or moving in the opposite direction, potentially adding value.”
After nearly seven years of a near-zero federal funds rate, the Federal Reserve didn’t raise rates in September. There is still speculation on whether the Fed will move before the end of the year.
When the Fed does move rates, it is PIMCO’s outlook that the Fed will raise rates toward the 2.0%-2.5% range over the next couple of years.
“This is likely to be the slowest, most gradual, most telegraphed rate hike in the history of the Federal Reserve,” according to Moore. “We expect them to start with a very small increase and then watch how the economy and markets react. If all goes well enough and the market absorbs the change without incident, they would then take another step.”
During a rising-rate environment, Moore — as does PIMCO — predicts more frequent periods of market volatility as the “Fed slowly reduces its influence.”
According to Moore, volatility is another opportunity where active management can benefit.
“While a hiking cycle can lead to rough patches, it can create more opportunity for an active manager to add value,” he says.
Moore explains how volatility can create buying opportunities for active investors.
“In choppy markets, many investors who get spooked may look to sell, and with new regulations limiting the capital and liquidity provided by banks, market participants are looking for other liquidity providers,” he says. “This can be advantageous to active investors who have the balance sheet to take advantage of outsized moves in the market.”
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