Europe at high inflation risk, says Franklin Templeton’s Michael Hasenstab
Europe and the US will face “very serious problems” with inflation if central banks do not return to normal after pumping so much money into the system, warned Michael Hasenstab, co-director of the international bond department at Franklin Templeton.
Hasenstab said Franklin Templeton is “very defensive in regards to interest rates”.
He said central bank activity was important, noting the ECB’s balance sheet has used just 7% of total bank assets, compared to 22% for the Fed.
The banks have acted in this way to try to avert a larger financial catastrophe, but Hasenstab added some financial markets are pricing in scenarios Franklin Templeton does not think are likely – creating investment opportunities.
“US Treasuries, for example, at 2% are pricing in something really horrible. Currencies in Asia look like they are pricing in an Italian default, not just a Greek default and Italian recession.”
UK gilts yield 2%; Bunds and Japanese Government bonds between 1% and 2%.
So, look elsewhere, Hasenstab recommended. Ten-year Brazilians yield 10.6%; Hungary’s debt 8.6%; Mexico’s 4.9%; and Chile’s and Poland’s 4.9%, for example.
“Although the world does not look that great, there are such relative dispersions that there are great opportunities. It is a great opportunity to take advantage of relative conditions in the rest of the world.
“Although there is weak growth coming from the US and negative growth from Europe, many countries like China, Poland, India and Indonesia have significant domestic demand stories enough to offset the shocks, and as a result none of them went through a recession in 2008-2009, and they should not do so now.”
He said such countries’ foreign currency reserve cushion was 20% higher than before the crisis. Developing countries have a combined $6.7trn, almost double the $3.7trn of developed markets.
“If there was a global shock, [developing economies] have only debt to GDP ratios of 40%, they could easily expand that to 60% or 70% of GDP and still be okay. Emerging markets will be a lot more stable than markets are currently pricing in.”
Inflation was another key focus of Hasenstab’s presentation to a fund conference in Mannheim this week.
He said that without the mitigating factors of the crisis, the pumping of liquidity would have created a 35% “inflation impulse”.
However, the effect of the stimulus was reduced because companies and whole economies have been deleveraging.
Hasenstab said, though, inflation pressure could ultimately be felt beyond the West.
He mentioned other inflationary impulses, too, such as supply pressure for food and fuel, and increasing demand from emerging markets, whose economic growth rates are 20% higher than they were before the crisis.
China, which has ‘exported’ deflationary pressure to the West over the past 10 years, now has wage pressure “and it will export these higher prices, so you have to remain defensive on interest rates”.
But he said 9% economic growth last year “answered questions about a ‘hard landing’.”
In regards Europe, Hasenstab said political action and moves to better fiscal integration were important.
And Italy is not Greece, “the debt dynamics are totally different”.
Europe’s problems, including probable restructuring of Greek debt and a recession, would cause volatility and weaken global trade growth, “but it is unlikely to be a repeat of 2009. PMI in Asia seems to be bottoming and their export pattern seems to be weakening, but nowhere near collapse.
He said that the markets can be effective at pricing in bad news, and pricing in very good news. “But the fact the market is bad at pricing in mediocrity” – which provides good investment opportunities in what Hasenstab said was now a “world just in a kind of mediocre state. Getting the right price for that is important.”