Pimco’s tail risks

Investment company Pacific Investment Management Co., (Pimco) recently gathered a range of major political and economic heavy weights to think through the future.  They popularized the term “new normal” to describe an era of below-average economic growth following the 2007-08 Global financial crisis, says that period is gradually entering a new phase. Economic growth globally will be converging toward lower, yet more stable top speeds and central bank interest rates will remain stuck below their pre-crisis equilibrium in a “new neutral,” outlining the firm’s expectations for the next three to five years.

Their uptake is not so new, that there is a new normal for growth- but that this is now lower than in the past. They are not so bullish about growth in the future.

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But importantly here are some things that could affect their almost rosy outlook.

Six key tail risks to the secular trends
1 With trend growth rates and inflation modest, policy rates low public balance sheets bloated and public debt high, few countries would have room to maneuver to deploy counter cyclical policy were the global economy to go into recession within the next five years.

2 The re-regulated, better capitalized global banking system allocates little of its balance sheet to making markets, resulting in greater likelihood of flash crashes, air pockets and trading volatility.

3 The trend away from energy scarcity and toward energy abundance creates big losers as well as winners and is only a net positive for global demand if the winners’ boost in consumption offsets the losers’ cut in consumption and capital spending.

4 Geopolitical conflicts have thus far been taken in stride by markets, but “disaster risk” is to some extent priced into financial assets today and is a source of volatility and downside risk to equity prices and credit spreads and upside potential to Treasury and Bund prices.

5 The distribution of global inflation outcomes has a right tail as well as a left tail; over our five-year horizon, a breakout of inflation to the upside of central bank inflation targets is not as unlikely as many seem to assume.

6 A trend is called nascent for a reason – there is a risk it does not develop – and there is risk to our optimistic baseline that foresees better economic policy in key emerging and developed economies and the possibility of future
breakthroughs in U.S. economic policy over our secular horizon. There remains a tail risk of political polarization in the eurozone and/or a British exit from the European Union. In China, the planned reforms are ambitious, but success is not assured, and capital account liberalization in particular will be challenging to accomplish in the time frame announced.