Michael Hasenstab’s Global Macro View
Last week, myself and a few others attended the Franklin Templeton Investment Conference and had a chance to hear from Michael Hasenstab, Ph. D., about his global macro view of the world. You may or may not know that Michael manages both the Templeton Global Bond Fund and the Templeton Global Total Return Fund. He currently manages more than $175 billion in bonds1 and is the Chief Investment Officer of Templeton Global Macro Group. His flagship fund (Templeton Global Bond fund) is in the top 1% of its category and has more than doubled the benchmark2, outperforming it by 4.9% annually over the past 10 years3.
Active Approach in Global Fixed Income
Michael began by saying that there are broad macroeconomic themes that have set the scene for an inflection point in bonds and that he believes passive investing in bond indices may no longer be such a good strategy. The government bonds that dominate global bond indices typically pay very little interest, often have deteriorating credit quality and are susceptible to higher interest rates in the future.
US Yields to move higher
He went on to discuss that he believes US interest rates will rise soon and that the Templeton Global Bond Fund is positioned for this with negative duration (-1.5) in the US. Janet Yellen (the Chair of the Board of Governors of the Federal Reserve System) has very clearly said she expects the Fed will raise rates this year if the economy meets her forecasts, but the market has not shifted yet as far as the Fed expectations and believes the pace of rises will be a little slower. Yields can spike up quickly if the Fed starts raising rates. This negative duration in the fund could counterbalance equity risk if we have equities sell off because of higher rates. Also, we don’t need inflation to move yields higher, we just need the risk of inflation. A challenge for portfolios is that bonds have been the counterbalance to equities. Unfortunately correlation is much higher now and it is possible that higher interest rates trigger losses in bonds and stocks.
He moved on to discuss how falling oil prices are a tailwind to the US economy going forward. Falling oil prices had a negative effect on the US shale industry and the US economy in Q1 but positives should now show up going forward as the US is still a net importer of oil. Falling prices at the pump will also help the consumer (who will have more cash in their pockets) and industry (lower input costs) which should both benefit the economy. He also pointed out that the Saudi’s are keeping prices low which keeps pressure on Iran and Russia and hurts the US shale industry, which has higher production costs. Michael expects lower oil prices to continue over the medium term as Saudi continues with this strategy due to the above factors.
The US labour market
The US labour market is now getting close to ‘full employment’ at 5.5% v the Fed’s target of 5.2%. The number of people and hours worked is rising and the next kicker will be inflation in labour costs. Job openings in the US are at the 2007 peak, but there is a structural shift as older Baby Boomers are leaving the job market and the labour force participation rate is falling, partly due to a structural skills mismatch.
Global GDP Growth
Michael expects analysts to revise US GDP growth upwards based on the above tailwinds and feels that the US consumer is continually underestimated. He also expects that many countries like Mexico (and other emerging markets) will benefit from US growth and lower oil prices. Finally if rates rise, it will be likely be against a backdrop of GDP growth – which is not necessarily a bad thing.
The weak euro
In the banking sector, there is no shortage of liquidity, but shortage of demand to make loans. Half of European growth is coming from Germany and half of that growth is from exports. The weak euro will lead to European growth in the short term and dominate the growth conditions. Michael’s funds are shorting the euro and buying central European currencies (Poland and Hungary) to take advantage of this. Central Europe exports are similar to Germany. Industrial production in Poland and Hungary are increasing and surprised the market to the upside recently.
By printing money, the government is forcing money into riskier assets. In Japan the issue is debt monetization. Debt to GDP is over 200%. Foreigners do not want to buy JGBs and the Bank of Japan is the sole funder of their own debt. Therefore he is short the yen and looking for capital to leave Japan and show up in other parts of Asia like Thailand.
In China they are at an inflection point. Leaving the low cost production stage and going up the value chain and are opening up business sectors to the non-state companies. Parts of China are in recession (rural) although the overall economy continues to grow at close to 7%. The job vacancy to job seeker ratio (urban) is at a 10 year high. The reason for this is a demographic shift. The single child policy has seen a reduction in the working population and wages have been going up. Because of this, Michael expects an increase in Chinese labour costs which could lead to inflation in countries that import from China, which is essentially every country. Also China is starting to respond to public pressure and is starting to clean up the environment. Any major risks to the Chinese economy can be addressed by the government through fiscal expansion and monetary easing for the next 2 years or so.
One needs to be very specific now with investing in Emerging Markets. Turkey could be a disaster and Mexico looks like it is in very good shape. Emerging Market currencies are at the lowest since records started, so the currencies look inexpensive compared to more developed countries.
Based on the above, he has a positive global macroeconomic growth outlook. He is concerned longer term that we are sowing the seeds of inflation. Putting all this money to work by governments has led to asset price expansion. Further down the road if we see inflation growth and GDP decline that is a big concern. There are not many interest rate opportunities at the moment and the opportunity is to short the euro and yen vs the dollar and to go long some emerging markets vs the dollar.
For more commentary and data on Michael’s view of the world, look at his Global Macro Shifts report: https://www.franklintempleton.com/forms-literature/download/GMSWP-PERWP
- Franklin Templeton as of 31 March 2015
- Citigroup World Government Bond Index
- Morningstar as of 17/6/15 with fund performance of 8.0% v 3.1% for benchmark.