Franklin Templeton’s Michael Hasenstab sees need to separate long term trends from short term market panic
Michael Hasenstab, co-director of the Franklin Templeton International Bond Department, says investors need to separate long term trends from short term market panic.
It’s critical to understand or disentangle the recent volatility in fixed income markets.
There were two major factors. One was the rise in interest rates, which, in our view (and what we’ve been positioning for), could likely be a permanent move higher. I consider this rise in rates from exceptionally and distortedly low levels in many countries as moving toward more normal levels. I don’t think we’re fully there yet in terms of an equilibrium level, but we’ve at least begun to adjust.
The other factor was just general risk-aversion, a bit of panic, contagion. That’s something that we’re always susceptible to for short periods of time. In our view, some of the recent fixed income losses due to interest rate exposure could be more permanent; however, we believe some of the recent factors causing declines due to market contagion and currency volatility may be more temporary.
There was probably a little position adjusting, particularly in some of the local emerging markets which in the short term were perhaps slightly overbought. Now that is being cleaned out. However, we feel the declines in emerging market currencies and some of the higher-yield spread sectors came on the panic that was tied to the typical reaction when, during a period of extreme market stress, regardless of fundamentals, all risk assets sell off. Since we believe those types of adjustments are due to temporary market contagion, we view this volatile period as a favorable buying opportunity that typically allows us to build positions at what we regard as attractive levels.
Tapering Doesn’t Equal Tightening
It’s important to remember tapering does not necessarily mean tight policy. It means the end of an excessively loose policy.
Additionally, the Fed indicated that any policy change would be a function of economic fundamentals, primarily regarding the strength of the US labor market. Given that inflation does not appear to be a near-term constraint, it’s unlikely the Fed would engage in tightening without some sort of economic improvement.
In our view, an environment where the Fed is tightening because of improving economic fundamentals would be beneficial for the rest of the world, and particularly emerging markets. I think this fear of liquidity being pulled out of emerging markets due to the Fed ending its bond purchasing program is overstated as we do not believe there would be a massive contraction of liquidity out of emerging markets. Our view is that this is likely to be more of an entry point for investors as opposed to an exit.
Even when the Fed turns off the tap, other markets are still flooding the market with liquidity – namely Japan.
Japan plays an important part of this total money creation exercise. The US has been pumping in approximately $1trn a year through mortgages and Treasury purchases that will ultimately end. However, Japan is just about to start injecting about 10% of its GDP a year, which is a little more than $1trn a year. Thus as the US begins to taper, Japan is beginning to ramp up. In our view, it doesn’t really matter whether the Fed prints or Japan prints or Europe prints. If it’s printed, it’s going to flow out.