At the September Cyclical Forum, PIMCO professionals will hone in on these recent events in financial markets, debating how much further the subprime market may fall, how the U.S. economy will be impacted, and how much fallout can be expected in global economies and markets.

Credit Markets

Global credit markets have clearly been strained from the fear raised by the subprime crisis. Investors have grown more risk averse, and borrowing costs for home buyers and corporations have increased substantially. These changes have effectively applied the brakes on what had been a bustling market for leveraged buy outs (LBO’s), private equity deals and high-yield bond issuance. The sharp increase in risk premiums has also sent credit derivatives indexes to new lows.

Mark Kiesel said in August that PIMCO’s decision to underweight U.S. credit and housing-related exposure has proven to be a solid investment call. Now, with credit spreads wider, risk/reward profiles have improved in some areas, such as bank loans, financial credits and credit derivatives. As markets continue to languish and risk premiums move further into line with fundamentals, Cyclical Forum participants will likely discuss potential credit investment opportunities.

Interest Rates

In keeping the Fed Funds rate steady for over a year, the Fed focused on low U.S. unemployment and the threat of an uptick in inflation. That turned around sharply in mid-August, when the Fed made outsized injections of liquidity into the system and cut its Discount Window lending rate. PIMCO maintains that the Fed will indeed cut the Fed Funds rate several times over the cyclical horizon – starting sooner than later – to stave off further ill effects of the U.S. housing slump, credit crunch and slowing economy. As such, the Fed’s U.S. inflation expectations might take a back seat to more pressing concerns. Paul McCulley noted in July that inflation expectations “should not be the be all and end all of monetary policy,” especially since the most common inflation model -- the Phillips curve -- does not fully incorporate wage inflation. At the September Cyclical Forum, PIMCO professionals will discuss the potential timing and scope of the Fed’s actions over the cyclical horizon.

Also up for discussion will be whether the current financial fallout from the subprime sector might stunt rate-hiking efforts of central banks. In early August, Emanuele Ravano said that European growth has been surprisingly strong, helped by the corporate sector, brisk exports and the expansion of the European Union. With the European Central Bank vigilant on inflation, markets have been expecting further rate hikes. But turmoil in financial markets might hamper those plans in the short run.

Emerging Markets

At PIMCO’s May Secular Forum, the global economic outlook for the 3-5 year horizon shifted from a “glass half empty” view to one where the glass is also “half full.” Global growth is likely to remain strong over the Secular timeframe, driven increasingly by emerging markets (EM), and global inflation is likely to show a modest pickup. This positive outlook, combined with significant economic improvements in EM countries, is making the EM asset class attractive, particularly for debt and derivatives denominated in local currencies, which typically offer higher interest rates and exposure to potentially positive currency movements.

As credit market investors have become more selective, Emerging Markets have felt some of the recent blow. But the setback is more likely to end up being a buying opportunity for stronger EM credits. Curtis Mewbourne recently pointed out that many EM countries remain supported by strong fundamentals, yet “emerging market investors do need to be aware of how the shift in risk perceptions will affect different countries within the EM universe.” At the September Cyclical Forum, PIMCO professionals will probably discuss which EM economies are likely to be the winners, and which ones should be avoided.

As always, China will fit prominently into the discussion about EM as well as the general global economic discussion. While PIMCO expects China to continue as a leading engine of global growth over the Cyclical Horizon, the Cyclical Forum will give participants a chance to update views on the near-term risks posed by China’s currency policy. Protectionist sentiment in the U.S. has grown louder at times, particularly as the rhetoric-heavy election cycle progresses. In June, Andrew Balls noted that “the pace of Chinese currency appreciation will be determined in Beijing,” and that U.S. policymakers may grow impatient waiting for more significant appreciation. At the September Forum, participants will likely weigh whether this impatience is leading to any significant policy movement, and determine the degree of risk that protectionist action poses.