PIMCO: Could economies and markets return to 2019 levels?

September 16, 2024

By Tiffany Wilding, PIMCO Economist

In the two-plus years since March 2022, when the Federal Reserve began hiking rates in an effort to tame U.S. inflation, the 10-year U.S. Treasury yield has swung around, violently at times, but broadly remained within a wide 3.5% to 5% range.

The sharp swings in the 10-year yield coincided with both renewed inflation scares (notably earlier this year) and financial stability scares (banking turmoil in March 2023). However, smoothing through these episodes, the 10-year U.S. Treasury note yielded 3.87% on the last trading day in 2022, yielded 3.87% on the last trading day of 2023, and just recently averaged 3.87% over the month of August 2024 despite the bout of global market volatility, including violent swings in Japanese currency and equity markets.

As of this writing, the 10-year yield was trading a little below its August average, but the broader question is this: Are recent swings just more fluctuations within a largely range-bound U.S. government bond market?

Possible return to pre-pandemic conditions in developed markets (DM)?

Market developments and unforeseeable shocks are prone to confound any forecast. That said, DM economies now look more like they did in 2019 than at any time since the pandemic. In that context, we think the more relevant question is this: Why are interest rates still well above where they were in 2019?

In five critical ways, economic conditions in developed markets (DM) today more closely resemble those of 2019. Consider these macro developments: 

• Inflation: After peaking between 8%–10%, headline inflation levels across developed markets are now back to 2-point-something. As of July 2024, DM aggregate inflation ($GDP-weighted) was 2.8%. This is still a little more than a percentage point above the 1.5% average headline inflation realized between 2016–2019, but it’s within reach of central bank targets. Core services inflation accounts for most of the difference, but cooling labor markets should support eventual normalization of these “stickier” inflation categories.
• Labor markets: The post-pandemic years of labor market imbalances and acute labor shortages are likely behind us. In the U.S., U.K., and Canada, the ratios of vacancies to unemployed workers (a measure of the balance between labor supply and demand) are now at or below 2019 levels. And with unemployment rates generally rising, labor markets arguably risk overshooting to the downside. 
• Real wealth: Government supports during the pandemic resulted in elevated accumulated real wealth balances of both households and businesses in many developed markets. This supported growth across DM to varying degrees, most notably in the U.S., where larger aggregate fiscal stimulus took longer to normalize. However, high inflation and low nominal savings rates have largely normalized those balances. According to DM flow of funds accounts, household liquid assets and net worth as a percentage of GDP are now at or below pre-pandemic trends across all DM, including the U.S., which was previously the positive standout. Evidence that U.S. real wealth has normalized can also be seen in delinquency data: According to a recent San Francisco Fed study, the normalization in these balances in the U.S. has coincided with a rise in delinquencies in various income groups.
• Supply chains: The pandemic snarled global supply chains. Measures of producer lead times, shipping costs, warehouse capacity, and logistical congestion all rose dramatically. While shipping costs on some routes have recently risen again as global logistical operators point to stockpiling due to rising trade uncertainty, the broader range of these measures is back to pre-pandemic levels, according to the New York Fed’s Global Supply Chain Pressure Index. 
• Inflation expectations: During 2015–2019, longer-term inflation expectations appeared to slip below central bank targets (typically 2%) following a decade of below-target inflation. The pandemic and subsequent inflationary shocks appear to have shifted longer-term expectations back to ranges more consistent with central bank targets. However, in general, inflation expectations have remained remarkably anchored during this period. The Survey of Professional Forecasters now projects 2% inflation over the next five years in Europe, similar to views of professional forecasters in the U.S. Likewise, market-implied inflation expectations (as measured by the 5-year, 5-year-forward breakeven inflation rate; i.e., the difference in yield between nominal and inflation-indexed Treasuries) have indicated longer-term expectations of 2%–2.5% inflation since January 2021.

Crucial exceptions

Despite all of these macroeconomic resemblances to 2019, there are notable exceptions. We could narrow them down to three:

• Government balance sheets: Without more pronounced fiscal austerity, a persistent long-term consequence of the pandemic would be larger government debt loads. As discussed in a recent PIMCO article ('Developed Market Public Debt: Risks and Realities'), the outlook for U.S. debt appears particularly challenging, with the potential to drive increases in term premium over time. 
• China: Downside risks to the Chinese economy have grown. The dramatic post-pandemic contraction in China’s property sector leaves the country increasingly reliant on an export-led growth strategy. Given increasing trade tensions – not only with Western DMs but now also with many emerging market countries – the sustainability of this strategy is in question. Without further direct consumer support from the government, which officials appear reluctant to provide, it’s difficult to see how China maintains a 5% growth target in 2025 and beyond. (Learn more in this PIMCO article, 'China’s Growth Evolution'.)
• Central bank policy rates: Although they have started to come down in some countries, central bank rates in general remain not only well above 2019 levels, but also above the optimal levels indicated by simple monetary policy rules. The implication of being “late” to cut relative to economic conditions is that now there may be room to cut rates more quickly across a range of economic scenarios.

Do 2019-like economies call for 2019-like rates?

Coming back to the initial question, with DM economies looking more like they did in 2019, why shouldn’t 10-year yields also establish new lower ranges? Maybe the 10-year U.S. Treasury yield doesn’t fall all the way back to 2019 levels, for a few reasons: Longer-term inflation expectations now appear more anchored at central bank targets rather than below; a lasting legacy of the pandemic will be higher government debt loads; and the U.S. election is a point of potential disruption.

However, against that, China’s post-pandemic property sector bust and potential limits to its export-led growth strategy mean it’s a greater risk to global growth than before. Also, comparing the current pricing on the 5-year, 5-year-forward U.S. real rate at 1.7% against our estimate of the real neutral interest rate range at 0%–1%, it appears there is room for rates to normalize under a range of economic scenarios.