Pimco says the yield curve inversion may be a false alarm for recession due to QE and US large-cap stocks are the 'best place to be right now'

• The yield curve inversion this time around not be a reliable indicator of a coming recession, a Pimco fund manager told Bloomberg.
• The "enormous amount of quantitative easing" from central banks may blunt the inversion's accuracy as a recession warning.

A key segment of the Treasury yield curve inverted this week for the first time in nearly three years, but fixed-income specialist Pimco told Bloomberg it may no longer serve as a reliable warning of an upcoming recession and recommended investors hold big-cap stocks.

"There's reason to believe that this time around, yield curve inversion may not be as good of an indicator as it has been in the past, particularly given the enormous amount of quantitative easing undertaken by global central banks," said Erin Browne, a fund manager at Pacific Investment Management Co., said in a televised interview.

On Tuesday, the yield on the 2-year Treasury note briefly rose above the 10-year yield for the first time since August 2019, crossing at around 2.39%. Other segments of the yield curve inverted earlier.

The rise in short-term interest rates above longer-term interest rates suggests bond investors expect restrictive financial conditions and a contraction in the economy. Treasury yields have been climbing this year as the Federal Reserve embarks on aggressively jacking up interest rates to tame hot inflation. The Fed began raising interest rates in March and has projected six more rate hikes in 2022.

"What is probably more critical is really looking at why the yield curve is inverting and some of the peculiarities around this yield curve inversion versus prior periods," said Browne.

The central bank is tightening monetary policy as US consumer price inflation sits near 8%. In addition to rate hikes, the Fed is winding down its massive quantitative easing program under which it purchased billions of dollars a month in securities. It restarted QE measures in 2020 to respond to the COVID-19 crisis.

More broadly, the world's major central banks since 2020 have pushed more than $11 trillion into the global economy to deal with the coronavirus crisis, according to the Atlantic Council.

There's been speculation this year that the US economy will enter a period of stagflation, with economic activity slowing while inflation stays hot. This has raised questions for investors about where they should allocate money.

"You can invest within equities and invest within pockets of the risk market, but moving up in quality is incredibly important, particularly as you move late-cycle," said Browne. "You want to be in companies that have high free cash flow generation, that have solid balance sheets, and that are able to withstand periods of economic weakness."

The "best place to be right now," is in US large-cap stocks, she said. "I like owning US large [caps] over all other regions. I think that small-cap will continue to be disadvantaged because of cost pressures, and large caps generally have better balance sheets and are able to withstand higher costs, which is one the biggest things afflicting markets right now, particularly corporates."