Pimco’s Clarida: Key Bond Market Risks and Opportunities in a Fragmenting World

Key Takeaways

• Pimco thinks the macro outlook supports high-quality fixed income over broad equities. Bonds offer attractive real returns with diversified fixed-income portfolios potentially yielding around 6%.
• A credit default cycle has begun, but it doesn’t resemble the 2008 financial crisis. Instead, opportunities lie in choosing bonds in both private and public markets, and in evaluating collateral quality and deal structures rather than buying broad credit indices.
• The US dollar is expected to remain the dominant reserve currency but may be overvalued and vulnerable to depreciation.

Bond investors are navigating geopolitical fragmentation, oil price shocks, and an ever-growing US budget deficit. We checked in with Pimco economic advisor and former Federal Reserve vice chair Richard Clarida about these issues in the context of a broader theme of “rupture and resilience” laid out in the firm’s 2026 Secular Outlook.

The economic outlook is increasingly driven by geopolitics. “For Pimco, it’s really a five-year outlook for the continued global fragmentation of security alliances, trading arrangements, and potentially even financial arrangements,” Clarida says. Read on for his thoughts on what this macroeconomic backdrop means for the bond market, including the onset of a private credit default cycle and opportunities in emerging market debt. This interview was edited for length and clarity.

Norton: Affordability is a big theme in the US midterm elections. If politics is now driving the economy, will the theme become more important to investors?

Clarida: Politicians probably aspire to address it. We recently had a rare piece of bipartisan legislation, the housing bill, whose goal is to improve affordability. The affordability focus is on the surge in inflation that began in 2021, which created unhappiness among tens of millions of workers. There’s a nuts-and-bolts macro piece to affordability. The Fed’s focus [under chief Kevin Warsh] is bringing inflation back down to 2% in an economy with strong productivity growth. The hope is that strong productivity growth shows up in wage gains and the Fed ultimately delivers on price stability. That would go a long way.

Income and wages are obviously central, but the K-shaped diagram shows two-thirds of Americans own their home and mostly own some equities, either directly or in a pension fund, while the rest are renting and mostly don’t have a lot of investment in the stock market. What’s unusual over the last six years is the magnitude of the increase in both housing values and equity wealth while the inflation surge eroded real incomes. It’s truer in the United States than in other countries, given that US stocks have driven global equity values.

Norton: Let’s talk more about your US outlook. Are you worried about a fiscal crisis?

Clarida: The US is on an unsustainable fiscal path under existing laws. The budget deficit is 6%-plus a year. Debt is growing faster than underlying GDP, and at some point, that unsustainable fiscal path will have to be corrected.

Our baseline view is that Washington will kick the fiscal can down the road throughout the rest of this decade. In the 2030s, Washington will finally, out of necessity, have to come together with some sort of fiscal consolidation. That’s because in the early part of the next decade, the Social Security and Medicare trust funds are exhausted, and under current law, if Congress doesn’t do anything, then benefits will be cut immediately by 20%-30%. The prospect of angering 80 million or 90 million voters who will see their benefit checks cut will eventually be sufficient motivation for Washington to put the US on a sustainable path.

Norton: How about in the credit markets?

Clarida: A credit default cycle has begun. We’re not saying this will be 2008. We don’t see a systemic problem. In certain big segments of the private credit markets, some funds have had to put gates on redemptions and outflows. We do think it’s a world of opportunity while recognizing that credit spreads are historically quite tight now. The opportunities are within individual companies and security selection as opposed to just overweighting a particular index. For companies in the public markets, cash flows are good and earnings are strong.

A lot of hyperscalers are issuing in both public and private markets. What is collateral? What is the structure of the vehicle? Who backstops the collateral in case of a repricing? It’s obviously useful to have access to both markets, but it’s also useful for investors to know how the deals are structured.

Norton: Let’s discuss your outlook for the dollar.

Clarida: We think it will be a dominant global currency for the foreseeable future, but we’re not saying it’s a one-way bet. Even a dominant reserve currency can rise and fall, as we saw in the 1980s in the Reagan years, and in the 1990s in the Clinton years.

The dollar has had a remarkable run for more than a decade. The reasons have changed. In the late 2010s, it was because the US economy was relatively strong and the Fed was hiking rates compared with Europe and Japan. In 2020, it was the flight to safety with the covid-19 pandemic. In 2022 and 2023, the Fed was hiking aggressively. Then OpenAI rolled out ChatGPT, and we had another leg up in the US exceptionalism theme. So the dollar, by some measures, is overvalued, and thus it could correct lower.

Norton: Pimco is bullish on bonds. Should the allocation in a 60/40 portfolio be greater than 40%?

Clarida: Obviously, individual investors need to make that decision with their investment advisors. Traditional valuation metrics favor boosting the allocation to bonds relative to history, simply because starting yield levels are the best available predictor of return on a quality fixed-income portfolio. Our baseline view is that central banks around the world, including the Warsh Fed, will maintain their credibility to keep inflation expectations anchored. It’s a much different investment thesis if you think that we’re going back to the 1970s of double-digit inflation.

You have yields now of 4.5% on a Treasury. Add some international diversification in dollar terms, including emerging markets, add some yield spread with mortgages, liquid credit, and some selective private credit, and you can get a starting yield on a dollar-denominated portfolio in the neighborhood of 6%. In a world where inflation rates are expected to come down into the 2% range, that’s an attractive real return. By contrast, equity valuations look pretty stretched because of optimism about AI and American exceptionalism.

Norton: How about globally?

Clarida: We are bullish on actively managed emerging market opportunities. We’ve had several stress tests for EM as an asset class. It’s not the asset class it was 30-40 years ago. They’re much more liquid. Fiscal outlooks are strikingly different. While most advanced economies other than Germany and Switzerland have government debt-to-GDP ratios north of 100%, most high-quality emerging markets that we would invest in have debt levels of 50%-70%. They have credible central banks that target inflation successfully. While some don’t want the currency risk, exposure can be hedged back to the preferred currency of the investor.

Norton: Key themes for Pimco include the end of globalization, the onset of fragmentation, and now, the potential for outright rupture. What are the implications of this?

Clarida: There’s a US-China dynamic. Europe has to come to a consensus on how to navigate between the two, and so-called middle powers are forming alliances. Some of this is for politicians and political scientists to think about, but it’s also relevant in markets. The range of sectors affected by government decisions will probably be broader.

For example, the AI discussion two or three years ago might have been one about technological innovation. Now, it’s about winning the artificial intelligence race. A wide domain of potential industries and sectors may need to be supported for economic security reasons. There will be changes in the economic landscape, winners and losers at the company, sector, and potentially the country level.