NEW YORK (Reuters) - U.S. bond giant Pacific Investment Management Company (PIMCO) said on Tuesday it favors bonds over other asset classes next year as it expects economic growth to have peaked and that inflation will slow down.
"Given current valuations and an outlook for challenging economic growth and diminishing inflation, we believe bonds have rarely appeared more compelling than equities," portfolio managers at PIMCO said in an outlook report.
U.S. Treasury yields, which move inversely to prices, have risen sharply over the past few months as investors increasingly expected interest rates to remain high for long because of a resilient economy. Meanwhile, rising concerns over increased government bond issuance have pushed investors to demand more compensation for holding long-term paper.
But a decline in inflation could prompt the Federal Reserve to cut rates sooner than previously expected, boosting the value of bonds. On Tuesday, yields dropped sharply after softer-than-expected consumer inflation data in October, suggesting the Fed may be done raising rates, with the market bracing for rate cuts by the first half of next year.
PIMCO said duration - or the sensitivity of a fixed income portfolio to changes in interest rates - looked attractive in the U.S. and in other markets such as the UK, Australia, and Canada.
In credit, the asset manager said it was cautious on corporate bonds due to expectations of an economic slowdown, while it favored mortgage-backed securities and some securitized bonds.
PIMCO sees the probability of a U.S. recession within one year at 50%.
"We maintain an overall neutral stance on equities, which appear richly valued by several measures, though they should return to more reasonable levels over time," it said.