May 15 (Bloomberg) -- Pacific Investment Management Co., which manages the world’s largest bond fund, doesn’t see the European currency union surviving in its present form.
“The status quo is no longer an option for Europe over the three to five year horizon,” Pimco Chief Executive Officer Mohamed El-Erian wrote in a report outlining the Newport Beach, California-based company’s medium-term economic outlook.
The most probable outcome is that the 17-nation euro area will evolve into a smaller union centered on France, Germany, Italy and Spain, and underpinned by much stronger coordination and financing, he said. A “big derailment” of the current pact is still a risk, according to El-Erian.
The euro fell to its lowest in almost four months against the dollar yesterday as a leadership vacuum in Greece prompted European officials to weigh prospects for the currency union’s first departure of a member state. Yields on Spain’s 10-year government debt climbed to the highest since November, while German yields reached a record low on haven demand.
Pimco is gloomier about the medium-term outlook for the world economy than it was a year ago, El-Erian wrote in the report published today on the company’s website. It sees advanced economies growing an average 1 percent per year over the next three to five years while emerging economies expand 5 percent annually. Last year, the money manager foresaw growth of 2 percent and 6 percent, respectively.
The U.S. “will look good, relative to Europe, outperforming in terms of growth and financial stability” over the next three to five years, El-Erian said.
The relative outperformance though “will do little to alleviate legitimate concerns about growth, jobs, inequality, debt and deficits,” according to Pimco.
“Extreme polarization” will prevent U.S. policy makers from striking sweeping agreements to resolve the country’s troubles, El-Erian wrote. “Political scrimmages rather than grand bargains” will be the order of the day, he added.
“In the process, the underlying structural fragilities of the economy will grow, in both economic and financial terms,” El-Erian said.
The Federal Reserve will seek to compensate for that by continuing to hold interest rates down for a number of years, penalizing savers, he added.
The U.S. central bank has said it expects to keep short- term rates at “exceptionally low levels” at least through late 2014. Its target for the federal funds rate -- the rate that commercial banks charge each other for overnight loans -- currently stands at zero to 0.25 percent.
Pimco sees inflationary pressures slowly building in the world economy over the next few years as “structural impairments” hinder job creation and central banks are tempted to hold interest rates too low for too long.
While China and emerging markets will continue to expand faster than the U.S. and Europe, their growth will be more volatile than in the past as they seek to reposition their economies to depend more on domestic demand, according to the Pimco executive.
Echoing comments first made by Fed Chairman Ben S. Bernanke in 2010, El-Erian called the outlook for the world economy “unusually uncertain,” with the potential for sudden shocks, either positive or negative.
Pimco’s outlook was crafted at a three-day forum held last week at its headquarters and repeats a tradition dating back almost four decades. The aim of the meeting is to establish the “guard rails” to observe when investing in coming years.
Among the guests this year were Zhu Min, deputy managing director of the International Monetary Fund, and Sheila Bair, former chairwoman of the Federal Deposit Insurance Corp.