About PIMCO’s Forums
Each quarter, PIMCO’s investment professionals from around the globe gather in Newport Beach to update the firm’s economic outlook. Three of these meetings – March, September, and December – are Cyclical Forums that focus on the global outlook for the next six to 12 months, while the May Secular Forum focuses on the outlook for the next three to five years.

PIMCO’s September Cyclical Forum
At the upcoming September Cyclical Forum, PIMCO investment professionals will update the firm’s outlook and discuss the latest economic, policy and market trends stemming from the ongoing financial stress and the slowdown of the U.S. economy. 

One question is expected to dominate the discussion: How much more deleveraging will occur in the global financial system? Or, as Paul McCulley puts it: Where are we on the “Reverse Minsky Journey,” where instability will eventually restore stability? The deleveraging question is crucial to determining the path that the global economy is likely to take in the short term. (The challenge of separating short-term considerations from longer-term factors was evident at our Secular Forum in May, where PIMCO’s investment professionals arrived at the consensus that although the global economy as a whole is still growing, the world is in the middle of a secular realignment that likely will create a series of global handoffs – growth, inflation, influence and wealth – that may not be orderly.)

Also likely to be on the table: the lingering effects of the bursting of the U.S. housing bubble, the ensuing global credit crunch, tapped-out consumers, the slowing U.S. and European economies, and the spike in inflation. The persistence of the weakness in many housing markets and the slowdown in economies that had been the biggest buyers of goods and services from developing nations is pushing the state of the global economy to the forefront, particularly in light of evidence that more regions are experiencing more knock-on effects than had been previously evident.

The endgame to all these issues may hinge on the policy responses from monetary and fiscal authorities around the world.

Policy Response
Increases in food and energy prices have put central banks everywhere in a very difficult position. In emerging markets, as Michael Gomez points out, policy makers are facing a tough decision between inflation and growth. They have so far been reluctant to fight inflation by hiking rates, choosing instead to maintain high growth. But this choice may bring difficulties in the long run.

Specific inflation factors to consider include how likely or unlikely it is that headline inflation will lead to wage-price inflation given slowing economic growth, how the key global central banks are likely to react individually and collectively and what effect their policy actions may have on weakening economies. McCulley has argued that it is hardly sophisticated to look at the threat of inflation without taking into account a variety of potentially countervailing factors, such as financial conditions, aggregate supply and demand, output caps and unemployment caps.

Also key for the global financial system will be the question of how and when the U.S. government will address the health of the government-sponsored mortgage agencies, Fannie Mae and Freddie Mac, as well as potential future threats of insolvency to other major financial institutions and their impact on the financial markets. And from where, if at all, will the capital that is necessary to continue repairing financial sector balance sheets be raised – sovereign wealth funds, private equity? 

The Deleveraging Paradox
As the financial system deleverages, it is attempting to raise capital and sell assets at the same time. As Bill Gross has pointed out, this is hard to do without lowering all asset prices in tandem, unless the system has a balance sheet of last resort. This paradox complicates any discussion of when the financial system will begin to start to function normally again.

Also paramount to any discussion of the financial system and broader economy: how much further U.S. home prices will fall and how much worse default rates will get. Trillions of dollars in risky mortgages threaten to lead to more write-offs that must be matched by raising more capital. This raises yet another paradox pointed out by Mohamed El-Erian: whether this recapitalization will necessitate asset sales that lead to a further reduction in mortgage and other lending that could in turn affect credit in other sectors and eventually the whole economy in what is known as a “negative feedback loop.” Koyo Ozeki has pointed out that the U.S. may learn some lessons about the role of the government in dealing with a bad debt crisis by looking at how Japan handled the collapse of its commercial real estate market a decade ago.

Economic Horizon
At the last Cyclical Forum in March, slowing economic growth took a back seat to the wild undulations in the global asset and credit markets. Currently, with signs of potentially worsening economic conditions in the U.S. as well as Europe, the discussion of the real economy is pushing to the forefront again.

Will the current weakness feed on itself? Will U.S. housing price deflation spill into consumer spending and corporate profits, leading to more layoffs and further consumer weakness in yet another vicious feedback loop? Or, can aggressive, well thought out policy put a floor under the U.S. housing market, the consumer and the flagging financial markets?

How will the cooling of the U.K. housing market affect the British consumer and economy, and how will the very different fiscal states of euro zone countries influence policy responses? Emanuele Ravano has argued that in the euro zone, the transmission mechanisms that will determine to what extent the current increase in inflation will cause deterioration are threefold: wages and international price competitiveness, real estate markets and public finances.

Investment Implications
The Forum also will examine what this all means for investments over the cyclical horizon. The broad repricing of risk in many of the world’s markets has raised opportunities where a lack of liquidity, distressed selling or a glut of supply is causing investments to be attractively priced relative to risk.

Extremely high-grade securities such as Agency mortgages have soared to record high spreads vs. Treasuries, as liquidity has forced many speculative buyers to sell their holdings. PIMCO has also identified value in a variety of products such as non-agency mortgages, bank loans and other credit trading at distressed price levels, particularly higher up the capital structure.

For Cyclical Forum recaps and discussions, please check back on www.japan.pimco.com in late September.