Beyond Bulls & Bears

Dr. Hasenstab: Behind the Markets’ Fear

Recently, some analysts and financial professionals have argued that the significant uncertainty plaguing the global economy is to blame for the dramatic volatility in markets. This uncertainty can be felt in everything from fears of a double-dip recession in the U.S., to turbulent Asian currency markets and the ongoing European sovereign debt crisis. Dr. Michael Hasenstab, SVP and Co-Director, International Bond Department, Franklin Templeton Fixed Income Group® and Portfolio Manager for the Templeton Global Bond Fund took a few moments recently to help us make sense of these situations.

 On the Fed’s Operation Twist and the Risk of a Double-Dip Recession:

Persistently high U.S. unemployment levels and anemic GDP growth prompted the U.S. Federal Reserve to announce what has been dubbed Operation Twist as a means of lowering long-term interest rates and encouraging investment. The Fed hopes to sell some of its shorter-dated Treasuries and replace them with longer-maturity Treasuries. This will ideally have the effect of reducing long-term interest rates on things such as mortgages and car loans, helping to boost economic growth.

Michael Hasenstab
Michael Hasenstab

But Dr. Hasenstab thinks the effect of Operation Twist is likely to be fairly muted, especially since interest rates are already quite low:

“The recent announcement by the Fed probably will have a fairly limited effect on economic activity in the U.S.; interest rates are already incredibly low, and monetary policy is already incredibly loose.”

Even though Operation Twist may not spur significant growth, Dr. Hasenstab thinks a second recession remains unlikely. Recoveries from financial crisis-induced recessions tend to take longer. And although growth remains weak, he notes that’s different from an actual major contraction – for which the conditions don’t appear to be present:

“If anything, most U.S. companies have underinvested in the last couple of years and that can be seen by the tremendous amount of cash on their balance sheets that they have not put to work. So there’s not a need for cleansing in either the investment or labor markets, and of course, the real estate markets have already had a huge correction. But, this is a recovery from post-financial market excess, so there is a lot of deleveraging. Typically, these types of recoveries are characterized by weaker-than-normal growth and also prolonged periods of higher unemployment. So, the conditions we are seeing today are not atypical, and they also don’t signal that we’re about to go into a major contraction.”

 On the European Sovereign Debt Crisis:

S&P’s recent downgrade of Italy’s sovereign debt sent shock waves through markets as fears of contagion spread. But Dr. Hasenstab does not believe markets should view Italy’s debt situation as equivalent to Greece’s; Italy, he says, is in better shape:

 “In the last couple of decades, Italy has actually undertaken pretty significant fiscal reform efforts to stabilize its debt-to-GDP ratio, unlike Greece which was on an explosive and expanding path. It’s true the level of debt is high in Italy, but it is also stable, and it is true that growth rates are fairly low, but they have also been fairly responsible in running good fiscal balances. So, the debt conditions in Italy are nowhere near as problematic as they are in Greece.”

As contagion fears spread, however, investors shun the debt of countries they perceive to be at risk, driving up those countries’ interest rates. This makes debt harder to service, turning the risk of contagion into something of a self-fulfilling prophecy. But even if market conditions were to pressure a large major borrower like Italy, Dr. Hasenstab thinks it’s unlikely this would result in a systemic crisis:

The European Central Bank has shown willingness when necessary to intervene in the government bond markets to prevent contagion effects from impacting countries that are not actually insolvent. The ECB most importantly is providing a tremendous amount of liquidity to the banking system. It is true that European banks are a bit more credit-constrained than those in the U.S. because they haven’t made a lot of the writedowns, but they also have tremendous access to liquidity and the capitalization of the major European banks is certainly adequate. So, provided the ECB continues to provide a ring-fence, the situation in Greece is unlikely to become systemic. It is going to be volatile… and there certainly are tail risk events that we are monitoring very closely. But, I think it actually could be a positive event for Europe to move beyond this. The market is already pricing in a significant restructuring so it wouldn’t necessarily be a surprise and as long as the ECB is there to provide the backstop and prevent contagion, we think it is manageable.”

On Currencies and Emerging Market Growth:

The currencies of some Nordic and Asian nations have been pressured in recent weeks, but Dr. Hasenstab still thinks they may represent good long-term value:

“There has been a lot of speculative pressure on many of the Asian currencies and Scandinavian currencies which we continue to believe have long-term value. In fact, I think the strong fundamentals of many of those regions are illustrated by the fact that a country like Indonesia went through the global financial crisis without ever going into a recession. And since the global financial crisis, many of these countries have further strengthened their government as well as corporate balance sheets.”

Even though emerging markets have not been immune from recent economic fears, many of them have fundamentals that have remained quite strong. And Dr. Hasenstab argues that loose monetary conditions in the developed world are likely to continue to bolster emerging market growth. Although developed market growth may be sluggish for a while longer, his outlook on the global economy remains positive:

“I just spent the last couple of weeks in Latin America and it’s clear that it and most other parts of the world are experiencing very different fundamentals – their growth is quite strong compared to developed markets. So even though growth in the US, Europe and Japan is likely to be weak and they will have lower demand for emerging market exports, on the flipside they are pumping a tremendous amount of money through low interest rates and quantitative easing into those economies and helping boost growth. So globally, our outlook remains reasonably positive….”


 Until next week, Beyond Bulls & Bears leaves you with a quote from the late Sir John Templeton:

 “It is well to remember that both bear markets and depressions are temporary. People do not remain pessimistic forever.”




Bond prices generally move in the opposite direction of interest rates. Thus, as the prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in developing markets involve heightened risks related to the same factors, in addition to those associated with their relatively small size and lesser liquidity. The use of derivatives and foreign currency techniques involve special risks as such techniques may not achieve the anticipated benefits and/or may result in losses. Changes in the financial strength of a bond issuer or in a bond’s credit rating may affect its value.

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