Pimco CIO Dan Ivascyn on the Biggest Fed Decision in Years

24:33I'm curious if you've seen a change from a business perspective and a distribution perspective over the last few years where you've had to go back out and convince clients of the role for bonds in the portfolio and remake that pitch to them. And whether there is sort of a persistent, maybe something that will last a while, skepticism. Okay, you don't get the same insurance effect. Meanwhile, yes, you get coupon payment, but when you look at the insane returns that people are getting in tech stocks, you're like, well, what's this little 5 % return getting for me? And so I'm curious whether the sales pitch or the client pitch has changed at all over time because of the experience of the last few years.

25:14It has. Now, we focus on value versus passive alternatives. So our pitch is, invest with PIMCO. We're going to provide you with a better experience relative to what you can get in passive portfolio alternatives. So we think over time, if we can do that, clients will come. And it was hard. Coming out of the GFC when interest rates were near zero, where policy rates were at zero or below zero for many, many years, it really planted the seeds for major change within the fixed income industry. And then you had the inflation, and then you had the very violent sell-off in 2022, where not only did bonds not insure much of anything, they themselves went down a lot.

25:51Yeah. The mark-to-market on those were insane at the time. I remember doing a headline that was like, this was for corporate bonds, but it was like demonstrational portfolio of IG bonds. And it was down like 30 % at that period. Anyone holding fixed income, especially as a retirement option would have been massively hit. Absolutely correct. And in some sense, it was a prerequisite to get value back in fixed income markets. But if you go back several years, because rates were near zero or outright negative in major parts of the developed world, people were forced to look for alternatives. What you've seen over that period is massive growth in floating rate, lower quality corporate credit.

26:32That's very unusual when you go back several decades. And historically, floating rate, lower quality corporate credit is quite dangerous because when you have an economic shock, short rates go down. That floating rate, lower quality credit, just as it becomes more risky, sees its yield drop and drop quite considerably, especially if policy rates or neutral rates are as low as some people may think. So you're getting paid less and the odds of default are going up. That's correct. And we have a dynamic now where you've seen the lower quality floating rate credit markets grow in the order of a couple trillion dollars in size.

27:04And that was due to the fact that it was really the only game in town. There was no real attractive yield at high quality markets. Today there is. What we know is coming up most likely in a few days is that these short rates are going to begin to go down again. So you have a really, really interesting dynamic in the market where people rushed into these floating rate sectors and segments of the market, their yields are going down. You don't have the ability to lock in those longer real rates. So we do think this could be a meaningful turning point. And I think, again, in looking at fixed income from the standpoint of a 30, 40, 50-year time horizon, it's really been the exception of the rule the last several years where you've had this dynamic in play, where duration was a really, really bad thing and where you really needed to perhaps reach a little bit to maintain an attractive income in some of the more economically sensitive or riskier areas of the bond market.

27:56Now, if you have a hard landing, this dynamic can turn quite quickly back towards the old days. If you have a softer landing scenario, this dynamic will play out much more slowly, But it does create what could be the next wave of interest into fixed rate longer maturities within the fixed income market.

28:35Maybe even a few strategic option plays on the side. The point is you're engaged with your investments and public gets that. That's why they built an investing platform for those who take it seriously. On public, you can put together a multi-asset portfolio for the long haul. Stocks, bonds, options, crypto, it's all there. Plus an industry leading 3.6 % APY high yield cash account. Switch to the platform built for those who take investing seriously. Go to public.com slash market and earn an uncapped 1 % bonus when you transfer your portfolio. That's public.com slash market.

29:30like your business. Across America, over 600 ,000 small businesses, from accountants and architects to photographers and yoga instructors, look to Hiscox Insurance for protection. Find flexible coverage that adapts to the needs of your small business with a fast, easy online quote at Hiscox.com. That's H-I-S-C-O-X dot com. There's no business like small business. Hiscox Small business insurance. Okay, so speaking of credit and floating rate loans, do you feel pressure or competition at all from, I guess, the proverbial growth of private credit, the booming private credit market? Is that something that either makes it harder for you guys to secure paper or maybe makes the yield on that paper a little bit lower?

30:17What does that mean for your business? From an investment perspective, it's actually a really good thing. And in fact, even some of the growth of the ETF market has been positive. A lot of these rules-based strategies we see in the ETF space, the daily disclosure of activity within ETFs, has created frictions in certain more complex areas of the market that have led to the ability to more easily generate active alpha within our strategies. On the private credit side, it's a bit more nuanced. We are seeing more risk get transferred into private markets, which ironically has made the traditional high-yield markets much more robust.

30:53I can't tell you how many times we look at credits within the high yield corporate bond space. We say, look, we're looking at these financials. Maturity's coming up. This company cannot afford to pay this coupon rate to refi their debt, only to find out a private credit manager has taken them out with a pick deal. So instead of having to pay the full coupon interest currently, they have the option in the private credit markets to get a more aggressively structured transaction. We've seen this dynamic off and on throughout my time within the industry. And again, it is leading to some friction in markets, some opportunity as well.

31:29So yes, if more and more risk gets transferred to the private markets over time, it will lead to a reduced opportunity set. But from an active investment management perspective, those types of frictions actually create opportunities to generate alpha versus passive alternatives. This is interesting. I just want to clarify. So from an abstract level, I certainly understand how market frictions are what create mispricings and therefore the opportunity to generate alpha. But when you talk about the private credit space creating these frictions, can you just sort of clarify that a little bit more like what that looks like or math it out for us?

32:06Yes. So again, in looking at, first of all, some of the lower quality areas of the market, a lot of these pretty significant flows have impacted technicals across the credit sector more broadly. So analyzing and understanding the type of risk transfer going on in the private markets can really improve your ability to generate return, make good credit decisions within the traditional high yield or even the bank loan universe. I think that another big dynamic in private credit today relates to a lot of flows within two insurance platforms. Insurance companies are regulated entities. They're mostly regulated based on rating.

32:44And this feels a little bit similar to even the years leading up to the global financial crisis, where there's increasing influence from rating agencies. Now, rating agencies try their best to rate risk and assess risk, but there's increasingly a gap between the type of structures necessary to put into certain vehicles that are source of demand for private credit relative to our own views on the inherent credit quality of those particular instruments. And the fact that you're back now even over the last few years to so much capital optimization going on across these platforms that there is opportunity to do your own work, compare that work to ratings out there across both the public and the private credit space, and be able to make really, really good relative decisions versus those entities, those big players and growing players in the market that need a rating, that they need some type of structuring in order to optimize capital under a evolving regulatory framework.

33:42So those are the type of frictions that we talked about earlier that are good to have around because it does allow you to generate return in mandates that are less inherently constrained in that regard. Since you mentioned regulatory framework, How closely are you following something like the Basel Endgame proposals? Because this is the forgotten event risk of this week is also we're supposed to get the unveiled Basel Endgame suggestions or proposal. And those include a lot of potentially new guidance for how banks hold things like MBS and treasuries and mark-to-market losses on things like that.

34:17Yeah, so we follow what's going on with Basel rules. There's also a lot of work being done across various insurance regulators. even a lot of work going on across the regulatory regimes that impact various mutual funds and other positions here in the U.S. and over in Europe. So these are going to be important. Again, from the standpoint of good, well-functioning markets, we think that a lot of these regulatory regimes should be looked at. We think that a lot of the regulation that got put in place post-global financial crisis turned out to be perhaps a bit backward-looking, a bit aggressive. But all these types of regulations create these types of frictions that we look to exploit, again in some of our more flexible active strategies.

34:57So they're going to impact what banks can do, what risk needs to get laid off. And we've seen increased activity even there too, with these various SRT transactions and other aggressive transactions on the capital optimization side. But again, all this may not be so good for financial market efficiency, but these types of activities are very, very good from an active asset management perspective in order to come in and take advantage of these frictions for the end investor. Are you involved at all in synthetic risk transfers? Is that something of interest to you? We are. In fact, I was a trader of this space back when I first joined PIMCO, you know, back in the late 1990s.

35:34And we have a lot of folks here that I've looked at. Oh, this is like old school SRT if you're talking about the 1990s. It is. And SRTs are similar in many respects. It's a different flavor, you know, each time. And it's an interesting segment of the market. They're simple deals to some degree, but then there's a lot of complexity in terms understanding waterfalls, how losses are allocated, the documentation details. So they tend to be popular in the sense that you look at it, the risk, and you say, hey, look, I could get a very, very attractive coupon if I avoid losses up to this point, I'll have a good investment outcome.

36:06But again, a lot of inherent complexity. So we've been involved for a long time. We've done a few deals recently. We think it's an interesting area of the market, but it's an area of the market where back a year and a half or so ago when the regional banks were going through a lot of challenges, there was really good value for the end investor sourcing that risk. Today, with all of the money chasing some of these opportunities, some folks apparently or appearing to compete based on market share as opposed to prudent underwriting, there's times where some of these SRT deals are getting done and getting done at levels quite advantageous to the banks that are selling that risk.

36:43And not surprisingly, when you have that dynamic in play, you're going to see more and more of these transactions. So it requires a lot of nuance and some good value there, but there's pockets of froth even in that SRT market today. That's interesting. By the way, listeners, if you're just tuning in, Tracy and I did an episode with Michael Shemmy several weeks ago all about how SRTs work. So a good primer to go back to and check that out. I want to go back to the macro for a minute and sort of where we started and thinking about where we're going over the next several years and we're in an era of very high deficits.

37:19Historically, you mentioned, you know, there's talk about, you know, all this like friend shoring talk and reorientation of supply chains. That's costly. Geopolitical tensions have risen. That's going to be costly on multiple fronts if it persists. And politics changes, you know, obviously there was the sort of more comfort with fiscal expansion and things like that. And, you know, in a way that we might not have expected years ago. All these things like, you know, looking out a few years, how are you thinking about these changes that are coming or these risks and how they're going to change the flavor of markets over time?

37:54Yeah. So a few points. One interesting that we had a pretty extensive discussion today. We didn't talk about inflation too much. Yeah. Tell us more. What's going to happen with inflation? That's yesterday's news. No, actually, we probably should. Tell us more. Yeah. But I bring that up only because we do think to answer your question, you know, Over the next several years, even though inflation may come down from a cyclical perspective, it's likely here to stay. So then why do you think that we've only seen such a modest increase in the neutral rate if inflation here is now going to be sort of like structurally at least somewhat higher?

38:27Well, we think inflation may be a little bit higher structurally. At least the base case, we think that the risks around inflation will likely be more symmetric. So again, you go back to the GFC in the years following the GFC, most of the challenge for central banks would get inflation back up towards target. Yeah, it kept missing on the downside. And we think over the next several years, for the reasons we talked about, inflation risks will be more symmetric, which creates opportunities for investors to source inflation protection across portfolios. We also think, to your point, there's going to be more geopolitical uncertainty.

38:58Deficits are high. Many countries, including the U.S., which jumps out as being a government that can't continue to run these types of deficits indefinitely. And we think because deficits are high, because market participants generally believe that central banks and fiscal agents had something to do with inflation this cycle, you're likely to have less policy activism on an ongoing basis. So this feels like a market the next several years that will have to stand on its own merits more than it has in the past. Less influence from policymakers, more local volatility, less synchronized growth cycles with the risk of meaningful geopolitical uncertainty as well.

39:41A lower strike price on the Fed put, so to speak? And probably a lower strike price on the put, but the power of the Fed may be less than it's been in the past because of this very, very challenging inflationary situation we were in after the very activist policies during the COVID period. So, yeah, I think it's premature to say that the Fed and other policymakers aren't going to be there during extreme bouts of volatility. There is a question, though, from our perspective as to whether they could be as impactful as they've been in the past. Again, good for active asset management, but there's a risk management reminder in there that you've got to be a little bit more humble about the risks of overshooting, the risks of harder landing scenarios, the risk that, you know, as fixed income investors, we're going to have to go it alone, so to speak, and not rely on central banks.

40:28to bail out some of the underperforming areas of the market. You know, Tracy, it's interesting when we had that volatility in early August, none of the Fed speakers played ball with the talk of like emergency rate cuts. Oh, yeah. Like, you know, because that was in there and they did not. And they were very cautious. No, they didn't engage at all. They didn't really talk about the market volatility. And they said, we're just going to see the data. Like, it was very interesting how like they were cool throughout the whole thing. I know it's only six weeks ago, but I've already forgotten that whole period.

40:55But some people were calling for 100 basis point emergency cut, right? OK, when I think about event risk on the horizon, OK, the return of inflation, the hard landing scenario, but also geopolitical risks, which you just brought up. And if I'm thinking back to the idea of bonds as a hedge and I'm thinking about U.S. treasuries, it feels like U.S. treasuries aren't necessarily a good hedge for a particular flavor of U.S. political risk. How do you hedge for that type of volatility? Well, one thing that we've done, and it's not just related to the election, is to maintain a lot of portfolio liquidity.

41:31Liquidity means flexibility. Liquidity is a form of positive optionality. If you have a volatility event associated with our election or some of these other geopolitical risks that are out there, markets can overshoot. I think a key theme in generating return for an active asset manager is being there to countertrade the market if you do have overshooting. And I think that this election setup is one where it's a coin flip. and uncertainty is only increasing going into this election period. So we don't yet have conviction in terms of what's going to happen. We just want to have a bit more flexibility.

42:05That's point one. Second point, when you step back and look at the likelihood of generating attractive returns in the next few years, the U.S. is not the only game in town anymore. Rates were negative elsewhere in the world, outright negative, not even on an inflation adjusted basis. And these markets have reawakened, particularly from the standpoint of a U.S. dollar-denominated investor. So you do have options versus the U.S. The Australian bond market, the U.K., both markets out-yield the United States. Opportunities to diversify into other developed markets. Even Japan, on a hedge basis, has some interesting yields out in the long end of the yield curve.

42:40So we have, over the course of the last several months, have been using the full breadth of the PIMCO platform, the flexibility across a lot of our mandates, to diversify a bit away from the U.S. And again, that theme will likely continue where investors to optimize their portfolio should look outside the U.S. at both higher quality and lower quality markets out there in the world. And we do think some diversification away from U.S. higher quality interest rate exposure makes a lot of sense at this point in the cycle. I'm gonna ask like a really ignorant question and maybe you're just gonna say, no, that's not a thing that, I do have a capacity to buy Chinese government bonds, which have done extremely well, and the long end of the curve has come way down there.

43:22We do. Do you have exposure to that market? We have very little exposure to their market. They got yields, 2 % type zone in the higher quality of the market, but an example of less synchronized global growth cycles. Their growth's slowing, no inflation problem. It, in theory, is a decent diversifier. I think the problem just in the market right now is a lot of that's priced into the Chinese market. So the last time we spoke to you, I think it was August 2022, something like that. Yeah. And a lot of turning points. Yeah. We turned it down. Well, and a lot of the conversation was about the potential for a recession, a housing slowdown, things like that.

43:58And of course, fast forward to September of 2024 and corporate credit has held up phenomenally well. I take the point about disparities between, you know, lesser quality and higher quality. The housing market has been pretty robust, more than a lot of people would have expected. Thinking back over the past couple of years, what have you learned from that experience and how do you incorporate it into the PIMCO investment strategy? Well, this was an exceptionally unique cycle. We had a global pandemic, something none of us had witnessed in our lifetime. Sudden stop of the economy, massive, massive policy response, and an inflationary environment that many of us didn't see in our actual trading career.

44:39The young folks at PIMCO, even less so. So I think it's just a reminder that the unexpected can happen. And it's important, again, to have appropriate humility from a portfolio construction perspective. Think about diversification carefully. Risk management's critically important, not just defensive risk management, but having a risk management mindset because you can go through these unique periods. And as we talked about earlier, when valuations are stretched, it doesn't necessarily take a global pandemic type shock to create some challenges and opportunities for the firm or the strategy that's well positioned.

45:15I think looking back on the last few years, a lot of this inflation likely will be perceived as being at least temporary or due to very, very unique COVID supply chain complications and this massive fiscal stimulus that occurred. But we got a lot to learn, a lot to analyze. And I think going forward, plenty of uncertainty as well. So, you know, we try to be careful about being too overconfident. We get the behavioral finance folks always in our ears reminding us that people like myself tend to be prone to overconfidence unless we protect our clients from our own natural instincts. And again, just trying to learn, continue to read the economic history books, compare it to the current environment.

45:54Again, leveraging the team, you know, investing is a team sport. And you don't have to take wildly big macro bets to just generate lots of small return across a variety of sectors, parts of the globe. And again, if you do that well, it adds up into a good client experience at the end of the day. All right, Dan Iveson, I'm so glad we could catch up with you in person on the West Coast. Thank you so much for coming back on Offline. Thank you so much, Dan. That was great. Thanks a lot, guys.

46:31Joe, that was fun. That was really fun. What a treat to get to talk to Dan Iveson. Right before Fed Day. Yeah. Also, I was thinking, like, can you imagine being in that room with Ben Bernanke and Richard Clarida? Actually, when he said that, I had this like, like, it didn't quite register to me. He's like, oh, we have our advisor, Ben Bernanke. And I was like, what does he say? And I was like, is he like speaking metaphorically? It's like, no, but when you're PIMCO, you can really hire Ben Bernanke on Fed Day to talk to you about what just happened. Yeah, must be nice. Okay, well, there's a ton to pull out of that conversation.

47:08One of the things that struck me was very early on, you know, he talked about the credit cycle and what's been going on there. And I guess the downsides of looking at aggregates, which is, even when you see credit spreads falling or staying very, very low in totality, it does conceal pockets of weakness and pain for like, the least quality names in there and parts of CRE. and things like that. And I think that is worth remembering as we kind of talk about, well, the Fed's cutting rates and we haven't had that hard landing scenario that a lot of people thought would emerge. There are these pockets of weakness out there.

47:46Totally. Which, of course, has contributed to why just so many people are confused about the economy because you can sort of point to anything and tell the story you want. I also thought it was sort of interesting. And, you know, I get like there's a lot of logic to it. This idea of like, okay, for a couple of years there, bonds did not play the role in people's portfolios that they might've gotten used to. And I really just think like we, and by we, I just mean like investors, like people who put their money with other people or in some form, like we just hit it so easy in the 2010s because like really it was just like this beautiful synergy of stocks and bonds, various flavors of 60, 40, what have you, like it all worked out and you like didn't lose money.

48:26And 2022 in particular was like a sharp reminder. And you like pointed to the stats, like, no, like that paradigm like broke in a really big way. And so the question to my mind is still like, okay, even if inflation is like come down, we do see fixed income providing this sort of insurance hedging role that it did. Like, are people going to be like totally comfortable allocating that much to fixed income, especially because of kind of what we were talking about at And there are these different macro dynamics, geopolitical dynamics, political dynamics that could change basically how bonds trade.

49:01One day in the future, we'll tell our children that a successful investment portfolio was basically just 60-40. And that was it. That's how easy it was. It was so easy. We didn't know how good we had it. But you're right. I do think the memories of that like very dramatic mark to market loss are going to stay with us for a while. while. So it was interesting to hear Dan talk about this idea of like having to go out to clients and repitch bonds as a hedging instrument in your portfolio. And I kind of I wonder how quickly attitudes will adjust once again. I guess it depends on what happens this week and beyond.

49:42We will see. All right. Shall we leave it there? Let's leave it there. This has been another episode of the All Thoughts podcast. I'm Tracey Alloway. You can follow me at Tracy Allaway. And I'm Joe Weisenthal. You can follow me at The Stalwart. Follow our producers, Kerman Rodriguez at Kerman Armin, Dashiell Bennett, who is out here in Newport Beach with us, Kale Brooks at Kale Brooks. Thank you to our producer, Moses Andam. For more OddLots content, go to Bloomberg.com slash OddLots, where we have transcripts, a blog, and a newsletter. And you can chat about all of these topics 24-7 in our Discord, discord.gg slash OddLots.

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50:46Thank you.

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