Clarida: "Powell (FED) will not make any cuts during the remainder of his term."

There are only two reasons that will cause the Federal Reserve to lower interest rates: a dramatic increase in unemployment and a rise in inflation . Neither is particularly likely for Richard Clarida, former Fed vice chairman and Managing Director at PIMCO in New York. He explained this during his interview with Juanma Jiménez, PIMCO's executive vice president, during the "Guidelines for Navigating a 2025 Full of Uncertainties and Challenges" forum hosted by El Confidencial and PIMCO. According to his analysis, although the impact of US President Donald Trump's policies will be clearly seen in the future, inflation will remain under control and any eventual deficit corrections will occur later.

During his conversation, he raised the notion of the "age of fragmentation," referring to the current political and economic landscape, in which humanity "is preparing to journey into a multipolar world." An era in which the dollar will maintain its dominant, albeit weak, position and states will stabilize with high levels of debt . Likewise, central banks will have to once again rely on monetary policy to revive their economies, although in the United States, the Fed will have greater fiscal space thanks to the dollar's hegemony.

QUESTION: Speaking of fragmentation, we were earlier discussing the old saying: "It's the economy, isn't it?" Now it seems it's no longer the economy, but politics. What does it mean to be in the age of fragmentation?

ANSWER: If we look at the last decade, the world has been fragmenting into regional security alliances, trade blocs, and, to some extent, regional currency zones. We're coming out of a period of globalization where economics and economic efficiency guided policy. Now, with Trump, we're in an era where policy and geopolitics drive the economy. This is going to be a period of amplified business cycles, with greater volatility in the economy and markets.

Finally, we have entered the era of fragmentation, with many countries, especially the US but not only, having a very large stock of sovereign debt and GDP ratios of around 100% in some cases. This will have significant implications for interest rate ratios and macro volatility in the future.

Q. One of the main concerns is fiscal debt, especially in developed markets. What is your opinion on fiscal debt and its sustainability?

A. Debt levels are currently very high relative to GDP in many states. Under current economic policies, we have seen several countries stabilize at high levels, without exploding. There are really only three predominant exceptions: Japan, France, and the United States. These three countries, in our estimation, due to their current economic policies, demographics, and growth projections, are headed toward a trajectory of explosive debt. At some point, an adjustment will be necessary. Debt cannot continue to grow indefinitely relative to the size of the economy.

Focusing on the United States, we expect the fiscal debt to be reduced over the next five years. By the beginning of the next decade, its Social Security and Medicare funds will be exhausted, and by then, under current legislation, benefits would have to be cut by 30%. At that point, it's very likely that when the 80 or 90 million retirees see their benefits cut, this will motivate politicians to balance the fiscal accounts.

Q. Given this debt, what should be the role of central banks today? What can they do?

A. We believe that due to high debt levels, and in the case of the US, rising debt, there is limited fiscal space. In the United States, because of the dollar's role as a reserve currency, we have more fiscal space than other countries, but eventually the rules of arithmetic cannot be avoided. And that leads us to believe that fiscal policy will be less useful as a tool to stabilize the economy, making monetary policy the only option once again.

The good news is that central banks have much more room for cuts to stabilize the economy than they had in the past decade, before the pandemic. During my time at the Fed, it was raised to 2.5%, which meant we only had 2.5% to cut when the economy slowed. In this cycle, we reached highs of 5.5%, and it's currently at 4.5%, so there's more room for maneuver.

"The dollar's dominant position will continue for at least the next five years, for the sole reason that there really is no other alternative."

Q. Speaking of the Fed, the Federal Reserve has a dual mandate: to maintain price stability and maximize employment. What do you think the Fed should do in the coming months?

A. In this case, monetary policy will depend on the data. We seriously don't see Powell raising interest rates in his last eleven months in office. What we do see is him sitting back and not making any cuts. Ultimately, we believe only two things could lead to a cut. The first is if the economy slows more than expected. We see a significant rise in unemployment, and we saw Powell indicate in his appearance last week and in his statements yesterday that if the labor market begins to break down, there will be cuts.

Another reason for a rate cut is if inflation continues to surprise the Fed. Currently, 12-month inflation is at 2%, and looking at core inflation, it's at 2.5%. If it weren't for Trump's tariffs and other policies, the Fed's conversation would be mission accomplished. The reason we currently believe there will be no change is because the Fed is expecting tariffs to lead to a noticeable increase in inflation, at least for six months. I think the Fed wants to be confident when deciding to cut, especially given the past four years in which inflation has been above targets.

Q. Now speaking of the dollar, what's your vision for its future? Could the era of fragmentation affect its role as the world's reserve currency?

A. Regarding the role of the dollar, I often quote John Connally, Richard Nixon's Treasury Secretary, when he was discussing the dollar with foreign countries: "The dollar is our currency and your problem." And to some extent, that's still the world we live in. As we enter the era of fragmentation, the dollar remains the dominant currency, both in foreign exchange and in lending by international banks. We predict that the dollar's dominant position will continue for at least the next five years. For the simple reason that there really is no other alternative.

That said, a dominant dollar and a dollar as a reserve currency do not translate to an appreciating dollar. Over the many decades in which the dollar was dominant, we have cycled from a strong dollar to a weak dollar. The latter has been a long period of strengthening, driven by the Fed's interest rate hikes and the safe haven it offered during COVID, to the recent impact of artificial intelligence and American exceptionalism. That's why we believe the dollar has entered the era of fragmentation overvalued, and we won't be surprised by it over the next five years.

Q. You've talked about tariffs and growth, and we've been talking all year about American exceptionalism. What will these tariffs mean for U.S. growth?

A. The theme of American exceptionalism was based on important fundamentals in 2023 and 2024. The economy grew above trend, and productivity was running at about 25%, a strong performance for the United States, while the technology sector delivered very exciting innovations, all while inflation remained low. This combination of above-average growth led to a powerful combination that resulted in strong gains in the equity markets.

I think we're not talking as much about American exceptionalism now because the focus is on tariffs, immigration policy, and other elements that are part of Trump's agenda. We believe that, at some point next year, we'll really know what the tariffs are and what the tax and immigration policies look like, and with that uncertainty resolved, there's a possible scenario for the theme of American exceptionalism to return. Again, that may not be the case, but we think many of the factors that contribute to this theme are still present today.

Q. Speaking of investment implications, everyone has been talking about the return on equity, but PIMCO has been talking about the return advantage of bonds. What does this advantage entail?

A: Well, a very important factor regarding fixed-income investments is that the best predictor of the total return of a quality bond portfolio is the initial yield. Indeed, the correlation between initial yields and final returns over the next five years is above 90%. The only exception to this rule was during the highly disruptive period between 2021 and 2022. This is because the bond market's worst enemy is high and volatile inflation. That's why the rise in inflation hit both bond and stock markets so hard.

However, this situation has led to a generational reset in bond yields. The reality is that in the decade before the pandemic, bonds didn't pay much; in fact, in the eurozone, the ratios were negative, so risk-based returns haven't looked this attractive in 20 years. Furthermore, with an active manager like PIMCO, we believe we can continue to deliver positive alpha above an indexed return. You know, it's not difficult to build a bond portfolio with a yield that's 400 basis points higher than underlying inflation, and historically, that's a pretty strong real return compared to the volatility of an equity portfolio.

Q. We've talked about debt sustainability, but it now seems we should focus on duration. How do you see the two?

A. Another basic metric in bond investing is the term premium, which is the bond reward that the investor earns or expects to earn by assuming interest or duration risk. Historically, in the bond market, the return to maturity of a 10-year bond is higher than that of a 1-year bond, since a riskier investment requires a higher return. That said, in many sovereign markets, including the United States, Europe, and Spain, maturities are typically 20, 30, or even 50 years. Not all duration risks or interest rate exposure are equal.

Currently, in the United States, our focus is on buying at what we call the midpoint of the yield curve, which is between 5 and 10 years. That number is currently around 100 basis points. Before the pandemic, that number was at best around zero and at worst below. We believe the shift to positive and its retention in its current range is due to the current high level of sovereign debt. As we have previously stated, at PIMCO, we believe that for now, the US is not paying enough for risk over longer terms, but that could change.

Q. Returning to stocks, their rise has been impressive, but there's another side to this. Stocks are expensive, but why is this and what are the risks?

A. To buy stocks, you first need to look at their premium. The equity premium is the difference between the return and the yield of a stock that an investor can expect to earn relative to the return they could receive from a bond portfolio. Because stocks involve greater risk, almost three or four times that of bonds, stocks usually earn a positive return relative to bonds. We believe the equity premium is currently essentially zero. We could be wrong. But it's essentially due to the enthusiasm for the Magnificent Seven and the high valuation of US stocks. If we look at historical data, stock valuations have only been this high once before, during the internet boom and subsequent bubble in the late 1990s. While past performance isn't necessarily indicative of future returns, we believe it should at least be a factor when comparing the composition of a portfolio between bonds and stocks.

Q. In recent years, the correlation between bonds and stocks has been positive. What can we expect for the future?

A. We've certainly seen this in the decades before the pandemic. Currently, what we're seeing is that quality fixed income provides important hedging value in a diversified portfolio because when equity prices fall, bond prices rise. The clear exception was 2022, but that year inflation was hovering between 5 and 9 percent, and central banks lagged behind the curve. What we've seen is that when inflation is below 2.5%, bonds typically provide the hedge value for equity risk. Given our thesis that US inflation will remain close to its 2% target, we believe the hedging value of bonds will be a significant benefit.

Q. Will inflation be transitory or persistent?

R. It will come down eventually.

Q. Will the dollar be strong or weak?

A. We will see a weaker dollar.

Q. Interest rates?

R. They will remain flat.

Q. And in Europe?

R. They will go down.

Q. Risks or opportunities in the market?

A. Many opportunities, with active management.

Q. Region of greatest concern currently?

A. A hot war in the Middle East or Europe that escalates to include the US.

Q. Gold as a safe haven asset?

A. Gold is having an incredible run, but it's not the only alternative to hedge against inflation, like inflation-indexed bonds.

Q. Cryptocurrencies: strategic or speculative assets?

A. I think stablecoins are legitimate and are going to become a real investment opportunity.