NEW YORK (Reuters) - Gregory Peters said he has reduced risk in the $695 billion of assets he helps oversee at PGIM Fixed Income, citing the threats that excessive U.S. inflation or economic stimulus could trigger a recession.
“We have been disciplined in trying to cut our risk,” Peters, a managing director and senior investment officer at PGIM Fixed Income, said on Wednesday at the Reuters Global Investment 2018 Outlook Summit in New York.
“This is not a statement on the fundamental picture, which I think is pretty decent,” he said. “Valuations have tightened, (and) risk-return is starting to get less favorable. What we’re setting up for potentially is a much more severe downturn when it comes.”
Peters’ caution contrasts from a year ago, when he correctly forecast broad gains in fixed income and U.S. equities after Republicans took control of the White House and Congress, and the uncertainty over who would become U.S. president had gone away.
Part of the caution derives from how U.S. Federal Reserve policy might change should U.S. President Donald Trump’s nominee to chair the central bank, Jerome Powell, lead a more hawkish approach to inflation than current chair Janet Yellen.
Peters expects the Fed to hike rates in December, and twice in 2018.
“We’re still in the same global growth, U.S. growth zip code that we’ve been in,” he said. “But I worry about accommodation coming off. I worry about central banks normalizing when the fundamental picture doesn’t really afford it.”
Longer-term U.S. rates will likely stay low, he said, with the yield on the 10-year Treasury note staying within 0.5 of a percentage point of where it is now, without reaching 3 percent. The yield was about 2.35 percent on Wednesday morning.
“How could I be wrong? Inflation,” he said.
“If inflation comes in hotter, then I think you’ll have this snap move,” but if the Fed reacts aggressively “it will be short-lived,” he said.
Peters has pared exposure to junk bonds, which he said had enjoyed “unrelenting” gains since the election.
He nonetheless called last week’s selloff a “healthy type of correction,” despite secular problems such as the “slow-moving train wreck” besetting retailers.
“I still think it’s an attractive asset class,” he said. “We had five days of weakness. Big deal.”
Peters also said he is “very underweight” mortgages, a sector he considers “super-expensive,” but could rebuild his stake if a downturn prompted investors in 2018 to ramp up their exposures by selling investment-grade corporate bonds.
Another big uncertainty is taxes.
Peters is concerned that Congress may implement tax cuts that fuel business growth at the expense of unwisely expanding the U.S. budget deficit.
He said that could disturb the comparatively steady growth and low economic and market volatility that have characterized the 8-1/2-year economic expansion.
“What I worry about is the sugar rush,” he said. “This is a point in time in the cycle when you’re trying to get your fiscal house in order.”
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Reporting by Jonathan Stempel and Jennifer Ablan in New York; Editing by Susan Thomas