AdviserVoiceSonal Desai Archives - AdviserVoice https://www.adviservoice.com.au/tag/sonal-desai/ Financial planner information & financial planner education/CPD - AdviserVoice Sun, 26 Jul 2026 21:30:00 +0000 en-US hourly 1 https://wordpress.org/?v=7.0.2 The Warsh Fed is a welcome return to orthodoxy says Franklin Templeton’s Fixed Income CIO  https://www.adviservoice.com.au/2026/06/the-warsh-fed-is-a-welcome-return-to-orthodoxy-says-franklin-templetons-fixed-income-cio/ https://www.adviservoice.com.au/2026/06/the-warsh-fed-is-a-welcome-return-to-orthodoxy-says-franklin-templetons-fixed-income-cio/#respond Sun, 21 Jun 2026 21:10:52 +0000 https://www.adviservoice.com.au/?p=112089

Sonal Desai

First impressions count, and Kevin Warsh came out as a hawk in his first press conference as the new Federal (Fed) Reserve chair, notes Sonal Desai, chief investment officer, Franklin Templeton Fixed Income.

“I was not surprised. I had been puzzled by how many people in the media and in the markets believed Warsh would come into the job simply to fulfill US President Trump’s desire for lower interest rates. I have argued in public and in client meetings that, based on his track record, if anything Warsh seemed likely to be the most hawkish Fed chair we had seen since Paul Volcker in the 1980s.

“His first press conference seemed to confirm this. Warsh stressed up front and repeatedly that the Fed can and will bring inflation back to the 2% target, after missing it to the upside for five straight years. He did not mince words or hide behind supply shocks. As markets found some relief in the announcement of a US-Iran deal and oil prices fell, he could have argued that the energy price shock will hopefully prove…dare I say,… “transitory.” Instead, he said the following:

“The Fed statement says that inflation is primarily determined by monetary policy. You bet it is. I’ve said for years inflation is a choice. You bet it is. And today I’m announcing that this Committee unambiguously and unanimously have decided we are going to deliver on that.”

“And, “We’ve missed for five years, and we’re going to fix that.”

“For a moment, I almost felt myself transported to an earlier stage of my career, listening to then European Central Bank (ECB) President Jean-Claude Trichet saying that inflation was the only needle in the central bank’s compass.”

The ECB, however, has a single mandate: its inflation target. The Fed has a dual mandate: price stability and full employment. Jay Powell had noted that a stagflationary energy shock could put the two goals in conflict, increasing inflation pressures while creating downside risks to employment and growth. Tightening monetary policy to contain inflation would then exacerbate growth risks, and vice versa. Kevin Warsh said something very different.

“I don’t believe that we have a cruel choice. I don’t share the view that […] Federal Reserve Chairmen show up at a podium like this and say you got to choose. And you’re going to have to decide whether you’re willing to tolerate higher inflation, to put more people at work. I don’t believe in that. What I believe is if we do our job, we can make strong growth, low prices and strong employment mutually compatible.”

She adds “To be fair, Jay Powell also always said that in the long term, low and stable inflation is a necessary precondition for strong growth and employment. But the fact that Kevin Warsh chose to stress this even as the Middle East crisis is not yet fully resolved is telling.

“Equally revealing was his assessment of the economic outlook and monetary policy stance. In a policy statement much shorter and factual than we’ve become used to, the Federal Open Market Committee characterized the pace of economic activity as solid, with strong investment and productivity growth and a stable unemployment rate in a job market that is keeping pace with labor force expansion. It acknowledged uncertainty but did not emphasize downside risks.

“The monetary stance, Warsh said, could best be characterised as uneven: it seems tight if you look at the housing market, but not if you look anywhere else, particularly at the performance of financial markets. This, Warsh argued, could reflect the differential impact of different monetary policy tools like interest rates and the Fed’s balance sheet. Again, a different and more hawkish position than Jay Powell, who insisted that monetary stance was moderately restrictive—something on which I have long disagreed.”

The impact of the size and composition of the Fed balance sheet will be assessed by one of five task forces that Kevin Warsh has appointed. The other four will be looking at Fed communication, data issues, the impact of innovation and new technologies, and the drivers and measurements of inflation. All will include both Fed staff and outside experts from a variety of backgrounds. With the announcement of these task forces, Kevin Warsh has indicated that he intends to overhaul the Fed’s monetary policy operations, but without prejudging the outcome. On the Fed balance sheet, his preference remains clear: He has always been critical of sustained quantitative easing, and his press conference comments confirm he would prefer a smaller balance sheet.

Equally clear is his preference for parsimonious communication. The policy statement was less than half the size of previous ones. And Kevin Warsh noted that his old mentor, George Shultz, used to say that press conferences are useful but, “when you have one, you want to make sure you have something important to say.”

She says, “Here, Warsh focused on something very important, which I both agree with and have long been concerned about. Over the past 15 years, a rather unhealthy dynamic has become entrenched between the Fed and financial markets. The Fed has been using forward guidance to influence market expectations as a way of giving further power to monetary policy. Financial markets have become almost single-mindedly focused on divining what the Fed will likely do. The Fed, in turn, has become extremely reluctant to disappoint market expectations.

“This circular process is deleterious at least at two levels. If the Fed is concerned about validating market expectations, it cannot be guided by its best assessment of the economic data. And if markets are mostly trying to anticipate the Fed’s behavior, financial prices carry little information about economic data and furthermore markets cannot be appropriately focused on fundamental risks—and price risk adequately. Warsh wants to move back toward a situation where financial markets react mostly to the economic data themselves; asset prices would then become a valuable additional source of information for the Fed. As a first step in this direction, the Warsh Fed has de facto abandoned forward guidance.

“As Warsh pointed out, it will take time for all these changes to feed through the pipelines and for financial markets to digest them. The initial market reaction, however, was clear. Investors have begun to more fully price in an interest-rate hike this year, which I see as a plausible outcome. The overwhelming consensus before the press conference was that Warsh would be dovish; by contrast, his hawkish tone came as quite a surprise and led to a selloff in rates and a strengthening in the dollar.”

“Overall, in my view the tone of Warsh’s first press conference as Fed Chair aligns much better with the economic reality on the ground and signals a welcome return to a more orthodox monetary policy, shows determination to bring inflation back to target while the economy continues to show resilience, and casts a critical eye on the risks of an oversized balance sheet,” Desai adds.

]]>

Sonal Desai

First impressions count, and Kevin Warsh came out as a hawk in his first press conference as the new Federal (Fed) Reserve chair, notes Sonal Desai, chief investment officer, Franklin Templeton Fixed Income.

“I was not surprised. I had been puzzled by how many people in the media and in the markets believed Warsh would come into the job simply to fulfill US President Trump’s desire for lower interest rates. I have argued in public and in client meetings that, based on his track record, if anything Warsh seemed likely to be the most hawkish Fed chair we had seen since Paul Volcker in the 1980s.

“His first press conference seemed to confirm this. Warsh stressed up front and repeatedly that the Fed can and will bring inflation back to the 2% target, after missing it to the upside for five straight years. He did not mince words or hide behind supply shocks. As markets found some relief in the announcement of a US-Iran deal and oil prices fell, he could have argued that the energy price shock will hopefully prove…dare I say,… “transitory.” Instead, he said the following:

“The Fed statement says that inflation is primarily determined by monetary policy. You bet it is. I’ve said for years inflation is a choice. You bet it is. And today I’m announcing that this Committee unambiguously and unanimously have decided we are going to deliver on that.”

“And, “We’ve missed for five years, and we’re going to fix that.”

“For a moment, I almost felt myself transported to an earlier stage of my career, listening to then European Central Bank (ECB) President Jean-Claude Trichet saying that inflation was the only needle in the central bank’s compass.”

The ECB, however, has a single mandate: its inflation target. The Fed has a dual mandate: price stability and full employment. Jay Powell had noted that a stagflationary energy shock could put the two goals in conflict, increasing inflation pressures while creating downside risks to employment and growth. Tightening monetary policy to contain inflation would then exacerbate growth risks, and vice versa. Kevin Warsh said something very different.

“I don’t believe that we have a cruel choice. I don’t share the view that […] Federal Reserve Chairmen show up at a podium like this and say you got to choose. And you’re going to have to decide whether you’re willing to tolerate higher inflation, to put more people at work. I don’t believe in that. What I believe is if we do our job, we can make strong growth, low prices and strong employment mutually compatible.”

She adds “To be fair, Jay Powell also always said that in the long term, low and stable inflation is a necessary precondition for strong growth and employment. But the fact that Kevin Warsh chose to stress this even as the Middle East crisis is not yet fully resolved is telling.

“Equally revealing was his assessment of the economic outlook and monetary policy stance. In a policy statement much shorter and factual than we’ve become used to, the Federal Open Market Committee characterized the pace of economic activity as solid, with strong investment and productivity growth and a stable unemployment rate in a job market that is keeping pace with labor force expansion. It acknowledged uncertainty but did not emphasize downside risks.

“The monetary stance, Warsh said, could best be characterised as uneven: it seems tight if you look at the housing market, but not if you look anywhere else, particularly at the performance of financial markets. This, Warsh argued, could reflect the differential impact of different monetary policy tools like interest rates and the Fed’s balance sheet. Again, a different and more hawkish position than Jay Powell, who insisted that monetary stance was moderately restrictive—something on which I have long disagreed.”

The impact of the size and composition of the Fed balance sheet will be assessed by one of five task forces that Kevin Warsh has appointed. The other four will be looking at Fed communication, data issues, the impact of innovation and new technologies, and the drivers and measurements of inflation. All will include both Fed staff and outside experts from a variety of backgrounds. With the announcement of these task forces, Kevin Warsh has indicated that he intends to overhaul the Fed’s monetary policy operations, but without prejudging the outcome. On the Fed balance sheet, his preference remains clear: He has always been critical of sustained quantitative easing, and his press conference comments confirm he would prefer a smaller balance sheet.

Equally clear is his preference for parsimonious communication. The policy statement was less than half the size of previous ones. And Kevin Warsh noted that his old mentor, George Shultz, used to say that press conferences are useful but, “when you have one, you want to make sure you have something important to say.”

She says, “Here, Warsh focused on something very important, which I both agree with and have long been concerned about. Over the past 15 years, a rather unhealthy dynamic has become entrenched between the Fed and financial markets. The Fed has been using forward guidance to influence market expectations as a way of giving further power to monetary policy. Financial markets have become almost single-mindedly focused on divining what the Fed will likely do. The Fed, in turn, has become extremely reluctant to disappoint market expectations.

“This circular process is deleterious at least at two levels. If the Fed is concerned about validating market expectations, it cannot be guided by its best assessment of the economic data. And if markets are mostly trying to anticipate the Fed’s behavior, financial prices carry little information about economic data and furthermore markets cannot be appropriately focused on fundamental risks—and price risk adequately. Warsh wants to move back toward a situation where financial markets react mostly to the economic data themselves; asset prices would then become a valuable additional source of information for the Fed. As a first step in this direction, the Warsh Fed has de facto abandoned forward guidance.

“As Warsh pointed out, it will take time for all these changes to feed through the pipelines and for financial markets to digest them. The initial market reaction, however, was clear. Investors have begun to more fully price in an interest-rate hike this year, which I see as a plausible outcome. The overwhelming consensus before the press conference was that Warsh would be dovish; by contrast, his hawkish tone came as quite a surprise and led to a selloff in rates and a strengthening in the dollar.”

“Overall, in my view the tone of Warsh’s first press conference as Fed Chair aligns much better with the economic reality on the ground and signals a welcome return to a more orthodox monetary policy, shows determination to bring inflation back to target while the economy continues to show resilience, and casts a critical eye on the risks of an oversized balance sheet,” Desai adds.

The post The Warsh Fed is a welcome return to orthodoxy says Franklin Templeton’s Fixed Income CIO  appeared first on AdviserVoice.

]]> https://www.adviservoice.com.au/2026/06/the-warsh-fed-is-a-welcome-return-to-orthodoxy-says-franklin-templetons-fixed-income-cio/feed/ 0 Of bots and men and investing in the age of AI, Franklin Templeton Fixed Income CIO shares investment outlook https://www.adviservoice.com.au/2026/03/of-bots-and-men-and-investing-in-the-age-of-ai-franklin-templeton-fixed-income-cio-shares-investment-outlook/ https://www.adviservoice.com.au/2026/03/of-bots-and-men-and-investing-in-the-age-of-ai-franklin-templeton-fixed-income-cio-shares-investment-outlook/#respond Sun, 01 Mar 2026 20:05:33 +0000 https://www.adviservoice.com.au/?p=109816

Sonal Desai

Franklin Templeton Fixed Income CIO Sonal Desai believes that as AI evolves at a faster pace, it will be a fluid situation, but identifying the industries and companies likely to win or lose in the AI revolution is a key priority for asset allocation.

“Investment strategy is never easy, but we have started this year with a remarkable confluence of shifting factors: technological, economic and geopolitical. Understanding how they will play out and interact becomes crucial to asset allocation,” she noted.

The artificial intelligence (AI) revolution and its potential impact is currently playing a dominant role in asset markets. “It has the potential to reshape our economy and disrupt most industries, but it is subject to profound genuine uncertainty, and it moves at high speed. Even for nimble-footed financial investors, it’s hard to keep up,” said Desai.

Through most of last year, the main story was the massive investment to build AI models and capabilities. Investors quickly bid up the valuations of the companies providing the “picks and shovels” for the AI revolution: Nvidia and the tech giants developing AI models.

“More recently, however, the sheer size of debt issuance underpinning this AI investment wave is becoming an important concern for markets. The focus has also shifted to the companies and industries that might suffer from AI competition, like software. Here there is high uncertainty, and obvious risks of short-term over-reactions.

“The focus on the potential losers comes partly from the fact that it’s hard so far to identify the companies and industries that can reap major efficiency gains thanks to AI. That’s because adoption of AI solutions at scale is likely to require more time. Companies need to identify the right AI models and solutions for their mission-critical areas; they will need to reorganise processes and operations and socialize the adoption. Adoption will also likely be uneven across both companies and industries.

“A second crucial factor is the differential distribution of investment opportunities across the world economy. Here the biggest structural story is the persistent rise of emerging markets. Over the past decade, and especially post-COVID-19, many emerging markets (EMs) have run prudent fiscal and monetary policies—in stark contrast with advanced economies.

“As a result, the EM asset class has already proved resilient to global macro disruption and should now find a more supportive macro environment in 2026. Therefore, on the EM sovereign side I see scope for some further spread tightening, as fiscal policies remain generally prudent and economic reform momentum continues. Meanwhile, I think EM corporate debt is likely to trade range-bound.”

“Europe looks attractive, but whether this is going to be just a cyclical story or turns into a structural one remains to be determined,” according to Desai.

“In the near future, European economies should benefit from a revival of investment policies and defense spending. Geopolitics plays an important role, as European leaders have converged on the need to bolster the continent’s own defense capabilities. For this to turn into a structural story, however, European governments will need to tackle long-overdue structural reforms, including reforms related to public spending. Rationalizing social safety nets seems indispensable to create the fiscal space for a prolonged public investment push. And simplifying regulations could go a long way toward unleashing the innovation and investment potential of the private sector. On both fronts, Europe has consistently disappointed. Courtesy of geopolitics, there is somewhat greater hope that this time might be different.

“I remain more bullish than consensus on the US economy. Households have demonstrated reliable resilience. The AI investment boom continues, and corporate investment seems to be broadening out from just AI. Productivity growth has accelerated. Last but not least, a new bout of fiscal stimulus should provide a boost in the first half of the year.”

Fiscal policy, however, is also the main cause of caution for the longer term. The fiscal deficit is projected to remain at around 6% of gross domestic product (GDP) for years to come. With debt held by the public nearing 100% of GDP and upside risks to interest rates, this is the Achilles’ Heel of the US economy. It can undermine confidence, puts upward pressure on funding costs, and raises the risk of a significant tax hike down the road.

The US dollar has remained under pressure on the back of its still-strong valuation and concerns about political polarization and the strength of US institutions, along with geopolitics. A more aggressive US foreign policy stance, which often relies on financial sanctions, has strengthened incentives for more countries to reduce their reliance on US dollar (USD) foreign currency (FX) reserves and on the dollar-dominated financial system. There are limits to the extent any country can decouple from the dollar, which still has a dominant share in global FX reserves, financial flows and trade payments. But at the margin it does reduce the USD’s attractiveness.

“Therefore, I believe the macro and geopolitical environment will continue to favor some diversification outside the US in sovereign, corporate and currency exposure, with EMs offering some of the most interesting opportunities. I would not take this case too far, however, given the lack of a credible alternative to the depth and liquidity of US asset markets, especially while they are supported by a robust growth story.

“To close, I would also like to reiterate my view that inflation is likely to remain stubbornly above target; with growth robust and the labor market showing signs of stabilisation, this suggests that the Federal Reserve’s easing cycle has already come to an end.”

]]>

Sonal Desai

Franklin Templeton Fixed Income CIO Sonal Desai believes that as AI evolves at a faster pace, it will be a fluid situation, but identifying the industries and companies likely to win or lose in the AI revolution is a key priority for asset allocation.

“Investment strategy is never easy, but we have started this year with a remarkable confluence of shifting factors: technological, economic and geopolitical. Understanding how they will play out and interact becomes crucial to asset allocation,” she noted.

The artificial intelligence (AI) revolution and its potential impact is currently playing a dominant role in asset markets. “It has the potential to reshape our economy and disrupt most industries, but it is subject to profound genuine uncertainty, and it moves at high speed. Even for nimble-footed financial investors, it’s hard to keep up,” said Desai.

Through most of last year, the main story was the massive investment to build AI models and capabilities. Investors quickly bid up the valuations of the companies providing the “picks and shovels” for the AI revolution: Nvidia and the tech giants developing AI models.

“More recently, however, the sheer size of debt issuance underpinning this AI investment wave is becoming an important concern for markets. The focus has also shifted to the companies and industries that might suffer from AI competition, like software. Here there is high uncertainty, and obvious risks of short-term over-reactions.

“The focus on the potential losers comes partly from the fact that it’s hard so far to identify the companies and industries that can reap major efficiency gains thanks to AI. That’s because adoption of AI solutions at scale is likely to require more time. Companies need to identify the right AI models and solutions for their mission-critical areas; they will need to reorganise processes and operations and socialize the adoption. Adoption will also likely be uneven across both companies and industries.

“A second crucial factor is the differential distribution of investment opportunities across the world economy. Here the biggest structural story is the persistent rise of emerging markets. Over the past decade, and especially post-COVID-19, many emerging markets (EMs) have run prudent fiscal and monetary policies—in stark contrast with advanced economies.

“As a result, the EM asset class has already proved resilient to global macro disruption and should now find a more supportive macro environment in 2026. Therefore, on the EM sovereign side I see scope for some further spread tightening, as fiscal policies remain generally prudent and economic reform momentum continues. Meanwhile, I think EM corporate debt is likely to trade range-bound.”

“Europe looks attractive, but whether this is going to be just a cyclical story or turns into a structural one remains to be determined,” according to Desai.

“In the near future, European economies should benefit from a revival of investment policies and defense spending. Geopolitics plays an important role, as European leaders have converged on the need to bolster the continent’s own defense capabilities. For this to turn into a structural story, however, European governments will need to tackle long-overdue structural reforms, including reforms related to public spending. Rationalizing social safety nets seems indispensable to create the fiscal space for a prolonged public investment push. And simplifying regulations could go a long way toward unleashing the innovation and investment potential of the private sector. On both fronts, Europe has consistently disappointed. Courtesy of geopolitics, there is somewhat greater hope that this time might be different.

“I remain more bullish than consensus on the US economy. Households have demonstrated reliable resilience. The AI investment boom continues, and corporate investment seems to be broadening out from just AI. Productivity growth has accelerated. Last but not least, a new bout of fiscal stimulus should provide a boost in the first half of the year.”

Fiscal policy, however, is also the main cause of caution for the longer term. The fiscal deficit is projected to remain at around 6% of gross domestic product (GDP) for years to come. With debt held by the public nearing 100% of GDP and upside risks to interest rates, this is the Achilles’ Heel of the US economy. It can undermine confidence, puts upward pressure on funding costs, and raises the risk of a significant tax hike down the road.

The US dollar has remained under pressure on the back of its still-strong valuation and concerns about political polarization and the strength of US institutions, along with geopolitics. A more aggressive US foreign policy stance, which often relies on financial sanctions, has strengthened incentives for more countries to reduce their reliance on US dollar (USD) foreign currency (FX) reserves and on the dollar-dominated financial system. There are limits to the extent any country can decouple from the dollar, which still has a dominant share in global FX reserves, financial flows and trade payments. But at the margin it does reduce the USD’s attractiveness.

“Therefore, I believe the macro and geopolitical environment will continue to favor some diversification outside the US in sovereign, corporate and currency exposure, with EMs offering some of the most interesting opportunities. I would not take this case too far, however, given the lack of a credible alternative to the depth and liquidity of US asset markets, especially while they are supported by a robust growth story.

“To close, I would also like to reiterate my view that inflation is likely to remain stubbornly above target; with growth robust and the labor market showing signs of stabilisation, this suggests that the Federal Reserve’s easing cycle has already come to an end.”

The post Of bots and men and investing in the age of AI, Franklin Templeton Fixed Income CIO shares investment outlook appeared first on AdviserVoice.

]]> https://www.adviservoice.com.au/2026/03/of-bots-and-men-and-investing-in-the-age-of-ai-franklin-templeton-fixed-income-cio-shares-investment-outlook/feed/ 0 Optimism at the edges: the future of monetary policy across the globe https://www.adviservoice.com.au/2025/09/franklin-templeton-fixed-income-economists-weigh-in-on-the-future-of-monetary-policy-across-the-globe/ https://www.adviservoice.com.au/2025/09/franklin-templeton-fixed-income-economists-weigh-in-on-the-future-of-monetary-policy-across-the-globe/#respond Sun, 28 Sep 2025 21:05:01 +0000 https://www.adviservoice.com.au/?p=106655

Sonal Desai

Franklin Templeton Fixed Income economists weigh in on the future of monetary policy across the globe

The findings are listed below covering the US, Europe, Japan economic outlook and outlook for currencies.

US economic review

US economy: Growth over inflation, for now

Policy easing to resume: Financial conditions have eased to mid-2020 levels. Inflation data, while stable, shows signs of persistence in non-housing services and input prices, indicating that the case for easing rests squarely on the perceived risks to employment.

Labor market slack is building, but it’s not all gloomy: Despite the slowdown in labor demand, wage growth has remained above 4% for the past year. Interestingly, wage growth has eased for lower-income groups, implying that tighter immigration has yet to translate into higher wages for low-skilled workers.

Cautiously optimistic on economic activity: July spending data confirmed that the “payback” from tariff front-running abated as spending rebounded, especially in durable goods, supported by real income gains. This is significant because, like goods-sector employment, durable goods are typically the first category to show signs of cooling. However, tariff-inflation and reduced transfer payments may soon pressure lower- and middle-income households. Corporate profits remain resilient, but margin pressures are rising due to significant tariff-related costs. Many firms are reportedly renegotiating supplier terms, restructuring supply chains, and/or passing increased costs on to customers. Meanwhile, corporate concerns over wage pressure have eased and the probability of layoffs remains limited. Regional Fed surveys show a gradual recovery in firm capital expenditure (capex) intentions, corroborated by rising new orders and imports for capital goods. A sharp upward revision to intellectual property investment in the second estimate of the second quarter GDP likely reflects a lift from enterprise spending on generative AI products, suggesting that firms are actively investing in productivity enhancing measures.

Inflation in transition; risks to the upside: Shelter inflation is easing and will likely continue to do so in our view, but non-housing core services inflation has begun to reaccelerate. The latter is a key area of concern since elevated wage inflation could continue to drive up prices in the most wage-sensitive parts of non-housing core services. Immigration constraints may exacerbate this issue. With goods inflation, the bulk of the tariff impact is likely still ahead of us. A large share of US imports remains duty-free and with importers reducing purchases from high-tariff countries; actual tariffs paid were just over 9% as of June compared to a theoretical rate of 16% based on 2024 import levels. We expect this gap to narrow in the months ahead. Producer prices may well be starting to reflect tariff impacts, and if they continue outpacing consumer prices, corporate profits may weaken, prompting firms to scale back hiring or even consider layoffs.

Fed policy: Market are anticipating a 25-basis-point interest rate cut in September, followed by another in December. However, rising tariff-driven inflation may limit further easing. In our view, the scope for meaningful declines in short-dated Treasury yields appears limited since Fed policy expected to normalise rather than turn overtly accommodative over the next year. Moreover, the bar for the Fed to signal a more aggressive easing stance remains high. At the long end of the yield curve, although term premium narratives have taken a backseat to near-term Fed policy expectations, the overall level of term premium remains elevated. Looking ahead, we expect term premium to rise, with the possibility for some bear steepening.

European economic outlook

EU economy: Cautious optimism due to fiscal hopes

Lackluster growth in the short-term, but economic revival through fiscal stimulus: Cautious optimism characterises our medium-term outlook for the euro-area (EA), due to the expected impact of Germany’s fiscal stimulus, which the market appears to be under-appreciating. Germany’s draft budget in June announced sizeable fiscal spending (amounting to approximately 20% of 2024 GDP) over the next four years, with significant front-loading expected. However, headwinds persist in the near term. The overall growth trend across the euro-area remains sluggish, with inventory building largely driving second-quarter growth [0.1% quarter/quarter (q/q) and 1.4% year/year (y/y), with growth]. Although exports were a negative contributor (-0.5% q/q), the payback from the front-loading of trade in the first quarter was lower than expected. More striking was the slowing in private consumption and in investments in the largest four EA economies (Germany, France, Italy and Spain), attributed to uncertainty and low confidence amid trade-related uncertainty.

Modest business optimism versus timid consumers: Nonetheless, leading indicators, such as business surveys, have shown improvement. The composite Purchasing Managers’ Index of manufacturing rose to a 3.5-year high in August. This trend is also being reflected in a clear improvement of the expectations component of the German Ifo index, driven by an expected positive impact from fiscal stimulus. In contrast, consumer confidence surveys remain weak, despite a modest pickup during the first quarter that has since flatlined. Consumers remain reluctant to spend, with savings still above pre-COVID-19 levels. As confidence returns, a high savings rate coupled with real income growth should support consumption over the medium term.

ECB—not overengineering monetary policy: As expected, the ECB left the policy rate on hold at its September meeting (at 2.00%) in a unanimous decision. The overall tone of the press conference was broadly unchanged from July, reiterating that the ECB is “still in a good place” but “not on a predetermined rate path.” A few hawkish tones were struck on the outlook and inflation. Growth risks are now seen as more balanced compared to July, mostly due to the US-European Union (EU) trade deal, which supposedly eliminates the risk of higher tariffs and EU retaliation risks (which we were always skeptical about). Regarding the near-term outlook, policymakers held a sanguine view of the growth trend in the first half of 2025. On inflation, the ECB noted that “the disinflationary process is over” meaning that most of the moderating forces from previous years will normalise. However, wage growth is expected to decline further, with labor markets expected to remain stable—a fundamental assumption of ECB policymaking.

The ECB updated its June growth and inflation forecasts. Growth in 2025 was revised higher to 1.2% from 0.9%, while the 2026 forecast was lowered to 1% from1.1%. Contrary to our expectations, the German frontloaded fiscal stimulus growth impact was not revised higher following the draft budget of late June. In our view, the potential impact has been underestimated. Meanwhile, inflation forecasts were revised down slightly, including confirmation of the undershoot in 2026.  In post-meeting comments, President Lagarde expressed that the ECB would not react to minimal inflation deviations from the target, assuming they remain small and temporary.

Overall, we do not envisage further rate cuts unless growth or inflation materially disappoint over the next six months, with the window for easing progressively narrowing as the German fiscal impulse should become more visible in 2026.

Rates—front end can steepen further, long end support will remain limited: The front-end of the yield curve has been well anchored since post-Liberation Day, with investors pricing out some easing after the ECB’s July meeting. There is scope for the curve to steepen in the 1–3-year sector as the German fiscal impulse becomes more tangible. Longer-dated maturities are likely to remain under pressure amid a broader global move and local drivers. As well as higher supply from Germany, anticipated Dutch pension reforms that are due to come into effect in January are expected to weigh on demand.

Japan economic outlook

Japan’s economy: October hike on the table

Growth—the resilient economy underscored by second quarter GDP numbers: The Japanese economy showed resilience in the second quarter 2025, with GDP growth rising by 0.5% q/q and 1.7% y/y. Private consumption and overall investment were solid, offsetting a flat public spending. Exports were strong, adding to growth, while imports were slower, resulting in a positive contribution to growth from net trade. Despite concerns over tariffs, Japanese firms, especially in the auto sector, managed to maintain export volumes by squeezing export prices. However, the third quarter is expected to see a slight decline in GDP due to adjustments in export prices and the impact of amendments to the Building Standards Act on private housing investment.

High-frequency indicators suggest a modest deceleration in growth for the second half of 2025, with large manufacturers’ sentiment improving and consumer confidence rising but the outlook worsening. Yet, services, which account for nearly 70% of GDP, continue to drive the economy forward, supported by a rebound in tourist flows. Despite a slower third quarter, we expect full-year growth should remain solid at 1.1% y/y.  Prime Minister Ishiba’s resignation paves the way for some political uncertainty over who the leader will be and how the fiscal package shapes up. These will be crucial not only for the economy but also for asset prices.

Inflation—the curious case of rice inflation: The headline consumer price index (CPI) remained strong at 3.1% y/y and core CPI (excluding fresh food) also at 3.1% y/y. Government subsidies have been distorting actual inflation, but underlying inflationary momentum remains strong. Food prices, particularly rice, continue to drive overall inflation, with manufacturers passing on higher costs to output prices. The Tokyo Ku area CPI showed a slight decline in August, but overall inflationary pressures persist. Weekly retail rice prices are again ticking up (chart below) after a dip in June-July indicating that prices are stickier and taking longer to revert to normal despite the government’s measures of releasing stockpiles. Sustained food inflation (especially of staples) can lead to inflationary expectations becoming more entrenched in households, a risk the BoJ has flagged earlier.

BoJ—gradual tightening to continue: The BoJ is expected to continue its gradual tightening trajectory, with a 25-basis-point rate hike anticipated in October and at least three more in 2026. Wage growth progression and the stickiness of food inflation are key factors likely to influence the BoJ’s future rate decisions. Despite long-end yields reaching record levels, we think the outlook for Japanese Government Bond (JGB) yields remains bearish due to fiscal expansion uncertainties until clarity emerges on Prime Minister Ishiba’s successor.

Overall, forecasters generally expect the Japanese economy to maintain resilient growth in 2025 and 2026, with GDP averaging 1.1% y/y in 2025 and slowing slightly to 0.8% y/y in 2026. Inflation is forecasted to remain above 3% for the rest of 2025, driven by high food prices and gradual but persistent services prices.

Currency outlook

US dollar (USD)

After a period of significant depreciation earlier this year, the dollar stabilised and has begun to realign with traditional cyclical drivers. Although the US Dollar Index (DXY) continues to trade at a discount to the weighted two-year rate differentials, the gap has narrowed. Our analyses confirm that short-end US yields have become more influential than global equities or commodities in shaping USD movements. This marks a departure from the earlier dominance of structural and policy uncertainties. Moreover, the sharp narrowing of the goods deficit, which bodes well for the current account position, and foreign investors’ return to US assets, particularly US equities, since April imply reduced balance-of-payments pressure on the USD to weaken.

However, despite these improvements, it may be premature to conclude that the dollar has bottomed out. The United States continues to run twin deficits—a fiscal deficit of around 6.5% of GDP and a current account deficit near 4%—both significantly worse than in 2018–2019. These imbalances could undermine the dollar’s attractiveness, even with its interest rate advantage. Moreover, the US’ yield advantage is expected to fade over time as the overall direction of monetary policy is geared toward easing. By mid-2026, the Fed is expected to be the only G10 central bank still easing policy, while others begin tightening. Relative growth has historically been of greater significance to foreign exchange markets, and although US economic growth has remained resilient, its relative performance compared to G10 peers is expected to become less exceptional. Additionally, Deutsche Bank’s research suggests that the curvature of the yield curve—not just the level of short-term rates—can significantly influence currency markets. A flattening of the curvature—where medium-term rates fall faster than short-term ones—signals weaker growth prospects and can deter capital inflows, which in turn is bearish for the USD.

Euro (EUR)

Fundamental and technical factors remain supportive of further euro appreciation, in our view, albeit relatively contained compared with its strong performance since March. As well as the cyclical support from an improving macroeconomy, structural trends remain in place that we believe should further underpin the euro: the increasing market size of the European Government Bonds (EGBs), rising credit quality, tighter sovereign spreads, and historically attractive yields.

On the demand side, international investors are driving flows for euro-denominated assets, although this trend is more evident in fixed income rather than equities. ECB data for the second quarter showed that non-EA investors bought a significant amount of EGBs. Despite a rise in interest from EA debt securities from the rest of the world, repatriation from the United States has been marginal. This is mostly attributable to ongoing EA purchases of US stocks, while being a net seller of US Treasuries. While investors positioning remains undoubtedly overweight the EUR, markets seem to underappreciate narrowing growth differentials with the United States in 2026.

Japenese yen (JPY)

Our broad call for a stronger yen in the medium-term remains unchanged. But we remain more on the sidelines in the near term. There are factors on both sides (yen and dollar) that are preventing USD/JPY from breaking lower, but we continue to believe that it is inevitable partly because of the yen’s cheap valuations.

Several factors are liming the yen’s strength in breaking out of current levels: the BoJ’s muted responses or forward guidance on further tightening, domestic political instability and the uncertainty over the new Prime Minister and government’s fiscal policies as well as extended short USD/JPY positioning despite recent correction. Until positioning adjusts materially, it will be hard for the yen to capitalise on dollar weakness (as we have seen in recent months). Technically, a Fed cut coinciding with a BoJ hike would be crucial for USD/JPY to trend materially lower, in addition to positioning adjustments. But for now, we believe domestic political and fiscal risks will limit a clear pivot in that direction.

Franklin Templeton Fixed Income team of economists including Sonal Desai, Chief Investment Office, Nikhil Mohan, Economist, Angelo Formiggini, Economist and Rini Sen, Economist.

]]>

Sonal Desai

Franklin Templeton Fixed Income economists weigh in on the future of monetary policy across the globe

The findings are listed below covering the US, Europe, Japan economic outlook and outlook for currencies.

US economic review

US economy: Growth over inflation, for now

Policy easing to resume: Financial conditions have eased to mid-2020 levels. Inflation data, while stable, shows signs of persistence in non-housing services and input prices, indicating that the case for easing rests squarely on the perceived risks to employment.

Labor market slack is building, but it’s not all gloomy: Despite the slowdown in labor demand, wage growth has remained above 4% for the past year. Interestingly, wage growth has eased for lower-income groups, implying that tighter immigration has yet to translate into higher wages for low-skilled workers.

Cautiously optimistic on economic activity: July spending data confirmed that the “payback” from tariff front-running abated as spending rebounded, especially in durable goods, supported by real income gains. This is significant because, like goods-sector employment, durable goods are typically the first category to show signs of cooling. However, tariff-inflation and reduced transfer payments may soon pressure lower- and middle-income households. Corporate profits remain resilient, but margin pressures are rising due to significant tariff-related costs. Many firms are reportedly renegotiating supplier terms, restructuring supply chains, and/or passing increased costs on to customers. Meanwhile, corporate concerns over wage pressure have eased and the probability of layoffs remains limited. Regional Fed surveys show a gradual recovery in firm capital expenditure (capex) intentions, corroborated by rising new orders and imports for capital goods. A sharp upward revision to intellectual property investment in the second estimate of the second quarter GDP likely reflects a lift from enterprise spending on generative AI products, suggesting that firms are actively investing in productivity enhancing measures.

Inflation in transition; risks to the upside: Shelter inflation is easing and will likely continue to do so in our view, but non-housing core services inflation has begun to reaccelerate. The latter is a key area of concern since elevated wage inflation could continue to drive up prices in the most wage-sensitive parts of non-housing core services. Immigration constraints may exacerbate this issue. With goods inflation, the bulk of the tariff impact is likely still ahead of us. A large share of US imports remains duty-free and with importers reducing purchases from high-tariff countries; actual tariffs paid were just over 9% as of June compared to a theoretical rate of 16% based on 2024 import levels. We expect this gap to narrow in the months ahead. Producer prices may well be starting to reflect tariff impacts, and if they continue outpacing consumer prices, corporate profits may weaken, prompting firms to scale back hiring or even consider layoffs.

Fed policy: Market are anticipating a 25-basis-point interest rate cut in September, followed by another in December. However, rising tariff-driven inflation may limit further easing. In our view, the scope for meaningful declines in short-dated Treasury yields appears limited since Fed policy expected to normalise rather than turn overtly accommodative over the next year. Moreover, the bar for the Fed to signal a more aggressive easing stance remains high. At the long end of the yield curve, although term premium narratives have taken a backseat to near-term Fed policy expectations, the overall level of term premium remains elevated. Looking ahead, we expect term premium to rise, with the possibility for some bear steepening.

European economic outlook

EU economy: Cautious optimism due to fiscal hopes

Lackluster growth in the short-term, but economic revival through fiscal stimulus: Cautious optimism characterises our medium-term outlook for the euro-area (EA), due to the expected impact of Germany’s fiscal stimulus, which the market appears to be under-appreciating. Germany’s draft budget in June announced sizeable fiscal spending (amounting to approximately 20% of 2024 GDP) over the next four years, with significant front-loading expected. However, headwinds persist in the near term. The overall growth trend across the euro-area remains sluggish, with inventory building largely driving second-quarter growth [0.1% quarter/quarter (q/q) and 1.4% year/year (y/y), with growth]. Although exports were a negative contributor (-0.5% q/q), the payback from the front-loading of trade in the first quarter was lower than expected. More striking was the slowing in private consumption and in investments in the largest four EA economies (Germany, France, Italy and Spain), attributed to uncertainty and low confidence amid trade-related uncertainty.

Modest business optimism versus timid consumers: Nonetheless, leading indicators, such as business surveys, have shown improvement. The composite Purchasing Managers’ Index of manufacturing rose to a 3.5-year high in August. This trend is also being reflected in a clear improvement of the expectations component of the German Ifo index, driven by an expected positive impact from fiscal stimulus. In contrast, consumer confidence surveys remain weak, despite a modest pickup during the first quarter that has since flatlined. Consumers remain reluctant to spend, with savings still above pre-COVID-19 levels. As confidence returns, a high savings rate coupled with real income growth should support consumption over the medium term.

ECB—not overengineering monetary policy: As expected, the ECB left the policy rate on hold at its September meeting (at 2.00%) in a unanimous decision. The overall tone of the press conference was broadly unchanged from July, reiterating that the ECB is “still in a good place” but “not on a predetermined rate path.” A few hawkish tones were struck on the outlook and inflation. Growth risks are now seen as more balanced compared to July, mostly due to the US-European Union (EU) trade deal, which supposedly eliminates the risk of higher tariffs and EU retaliation risks (which we were always skeptical about). Regarding the near-term outlook, policymakers held a sanguine view of the growth trend in the first half of 2025. On inflation, the ECB noted that “the disinflationary process is over” meaning that most of the moderating forces from previous years will normalise. However, wage growth is expected to decline further, with labor markets expected to remain stable—a fundamental assumption of ECB policymaking.

The ECB updated its June growth and inflation forecasts. Growth in 2025 was revised higher to 1.2% from 0.9%, while the 2026 forecast was lowered to 1% from1.1%. Contrary to our expectations, the German frontloaded fiscal stimulus growth impact was not revised higher following the draft budget of late June. In our view, the potential impact has been underestimated. Meanwhile, inflation forecasts were revised down slightly, including confirmation of the undershoot in 2026.  In post-meeting comments, President Lagarde expressed that the ECB would not react to minimal inflation deviations from the target, assuming they remain small and temporary.

Overall, we do not envisage further rate cuts unless growth or inflation materially disappoint over the next six months, with the window for easing progressively narrowing as the German fiscal impulse should become more visible in 2026.

Rates—front end can steepen further, long end support will remain limited: The front-end of the yield curve has been well anchored since post-Liberation Day, with investors pricing out some easing after the ECB’s July meeting. There is scope for the curve to steepen in the 1–3-year sector as the German fiscal impulse becomes more tangible. Longer-dated maturities are likely to remain under pressure amid a broader global move and local drivers. As well as higher supply from Germany, anticipated Dutch pension reforms that are due to come into effect in January are expected to weigh on demand.

Japan economic outlook

Japan’s economy: October hike on the table

Growth—the resilient economy underscored by second quarter GDP numbers: The Japanese economy showed resilience in the second quarter 2025, with GDP growth rising by 0.5% q/q and 1.7% y/y. Private consumption and overall investment were solid, offsetting a flat public spending. Exports were strong, adding to growth, while imports were slower, resulting in a positive contribution to growth from net trade. Despite concerns over tariffs, Japanese firms, especially in the auto sector, managed to maintain export volumes by squeezing export prices. However, the third quarter is expected to see a slight decline in GDP due to adjustments in export prices and the impact of amendments to the Building Standards Act on private housing investment.

High-frequency indicators suggest a modest deceleration in growth for the second half of 2025, with large manufacturers’ sentiment improving and consumer confidence rising but the outlook worsening. Yet, services, which account for nearly 70% of GDP, continue to drive the economy forward, supported by a rebound in tourist flows. Despite a slower third quarter, we expect full-year growth should remain solid at 1.1% y/y.  Prime Minister Ishiba’s resignation paves the way for some political uncertainty over who the leader will be and how the fiscal package shapes up. These will be crucial not only for the economy but also for asset prices.

Inflation—the curious case of rice inflation: The headline consumer price index (CPI) remained strong at 3.1% y/y and core CPI (excluding fresh food) also at 3.1% y/y. Government subsidies have been distorting actual inflation, but underlying inflationary momentum remains strong. Food prices, particularly rice, continue to drive overall inflation, with manufacturers passing on higher costs to output prices. The Tokyo Ku area CPI showed a slight decline in August, but overall inflationary pressures persist. Weekly retail rice prices are again ticking up (chart below) after a dip in June-July indicating that prices are stickier and taking longer to revert to normal despite the government’s measures of releasing stockpiles. Sustained food inflation (especially of staples) can lead to inflationary expectations becoming more entrenched in households, a risk the BoJ has flagged earlier.

BoJ—gradual tightening to continue: The BoJ is expected to continue its gradual tightening trajectory, with a 25-basis-point rate hike anticipated in October and at least three more in 2026. Wage growth progression and the stickiness of food inflation are key factors likely to influence the BoJ’s future rate decisions. Despite long-end yields reaching record levels, we think the outlook for Japanese Government Bond (JGB) yields remains bearish due to fiscal expansion uncertainties until clarity emerges on Prime Minister Ishiba’s successor.

Overall, forecasters generally expect the Japanese economy to maintain resilient growth in 2025 and 2026, with GDP averaging 1.1% y/y in 2025 and slowing slightly to 0.8% y/y in 2026. Inflation is forecasted to remain above 3% for the rest of 2025, driven by high food prices and gradual but persistent services prices.

Currency outlook

US dollar (USD)

After a period of significant depreciation earlier this year, the dollar stabilised and has begun to realign with traditional cyclical drivers. Although the US Dollar Index (DXY) continues to trade at a discount to the weighted two-year rate differentials, the gap has narrowed. Our analyses confirm that short-end US yields have become more influential than global equities or commodities in shaping USD movements. This marks a departure from the earlier dominance of structural and policy uncertainties. Moreover, the sharp narrowing of the goods deficit, which bodes well for the current account position, and foreign investors’ return to US assets, particularly US equities, since April imply reduced balance-of-payments pressure on the USD to weaken.

However, despite these improvements, it may be premature to conclude that the dollar has bottomed out. The United States continues to run twin deficits—a fiscal deficit of around 6.5% of GDP and a current account deficit near 4%—both significantly worse than in 2018–2019. These imbalances could undermine the dollar’s attractiveness, even with its interest rate advantage. Moreover, the US’ yield advantage is expected to fade over time as the overall direction of monetary policy is geared toward easing. By mid-2026, the Fed is expected to be the only G10 central bank still easing policy, while others begin tightening. Relative growth has historically been of greater significance to foreign exchange markets, and although US economic growth has remained resilient, its relative performance compared to G10 peers is expected to become less exceptional. Additionally, Deutsche Bank’s research suggests that the curvature of the yield curve—not just the level of short-term rates—can significantly influence currency markets. A flattening of the curvature—where medium-term rates fall faster than short-term ones—signals weaker growth prospects and can deter capital inflows, which in turn is bearish for the USD.

Euro (EUR)

Fundamental and technical factors remain supportive of further euro appreciation, in our view, albeit relatively contained compared with its strong performance since March. As well as the cyclical support from an improving macroeconomy, structural trends remain in place that we believe should further underpin the euro: the increasing market size of the European Government Bonds (EGBs), rising credit quality, tighter sovereign spreads, and historically attractive yields.

On the demand side, international investors are driving flows for euro-denominated assets, although this trend is more evident in fixed income rather than equities. ECB data for the second quarter showed that non-EA investors bought a significant amount of EGBs. Despite a rise in interest from EA debt securities from the rest of the world, repatriation from the United States has been marginal. This is mostly attributable to ongoing EA purchases of US stocks, while being a net seller of US Treasuries. While investors positioning remains undoubtedly overweight the EUR, markets seem to underappreciate narrowing growth differentials with the United States in 2026.

Japenese yen (JPY)

Our broad call for a stronger yen in the medium-term remains unchanged. But we remain more on the sidelines in the near term. There are factors on both sides (yen and dollar) that are preventing USD/JPY from breaking lower, but we continue to believe that it is inevitable partly because of the yen’s cheap valuations.

Several factors are liming the yen’s strength in breaking out of current levels: the BoJ’s muted responses or forward guidance on further tightening, domestic political instability and the uncertainty over the new Prime Minister and government’s fiscal policies as well as extended short USD/JPY positioning despite recent correction. Until positioning adjusts materially, it will be hard for the yen to capitalise on dollar weakness (as we have seen in recent months). Technically, a Fed cut coinciding with a BoJ hike would be crucial for USD/JPY to trend materially lower, in addition to positioning adjustments. But for now, we believe domestic political and fiscal risks will limit a clear pivot in that direction.

Franklin Templeton Fixed Income team of economists including Sonal Desai, Chief Investment Office, Nikhil Mohan, Economist, Angelo Formiggini, Economist and Rini Sen, Economist.

The post Optimism at the edges: the future of monetary policy across the globe appeared first on AdviserVoice.

]]> https://www.adviservoice.com.au/2025/09/franklin-templeton-fixed-income-economists-weigh-in-on-the-future-of-monetary-policy-across-the-globe/feed/ 0 The fog of trade war and why Franklin Templeton is calling for at most one rate cut this year, with some probability of none https://www.adviservoice.com.au/2025/03/the-fog-of-trade-war-and-why-franklin-templeton-is-calling-for-at-most-one-rate-cut-this-year-with-some-probability-of-none/ https://www.adviservoice.com.au/2025/03/the-fog-of-trade-war-and-why-franklin-templeton-is-calling-for-at-most-one-rate-cut-this-year-with-some-probability-of-none/#respond Sun, 23 Mar 2025 20:14:30 +0000 https://www.adviservoice.com.au/?p=102100

Sonal Desai

Sonal Desai, Chief Investment Officer, Franklin Templeton Fixed Income believes markets have been excessively worried about stagflation risk and are now too confident that the Fed would rush to support growth even if inflation turns back to a rising path.

“Financial markets saw this week’s Federal Reserve (Fed) policy meeting as dovish. I’m not so sure. The Fed now projects slower growth and higher inflation compared to its December forecasts. The reduction in expected growth is meaningful, by 0.4 percentage point (pp) this year and 0.2 pp next year—though the unemployment forecast is virtually unchanged, with a mere 0.1 pp uptick for this year, probably reflecting tighter immigration policy. Core personal consumption expenditure inflation has been revised higher by 0.3 pp this year, but with no change for 2026 and 2027. In other words, the likely bump in inflation caused by tariffs is expected to be, yes, transitory. Some reporters baited Fed Chair Jerome Powell on the “transitory” label, which became infamous after the persistent inflation of 2021-2024. This time, however, there are solid reasons to expect that an acceleration in inflation would not last. Unlike in the post-pandemic period, the supply shock (from tariffs, in this case) is not expected to be validated by a massive expansion in government expenditures.

“On policy interest rates, the median of the “dots” still signals two rate cuts this year, the same as last December. That’s why most investors saw this as a dovish shift: The Fed projects higher inflation but still intends to cut rates, and by the same amount as previously.

“I disagree with this interpretation. Powell explained that, first, the Fed’s baseline expectation for now is a temporary shock to inflation, which the central bank would rightly look through; but second, more importantly, the main reason why the policy forecast is unchanged is that policy uncertainty is now so high that the Fed cannot yet predict with any confidence whether it will need to keep rates higher or lower. In other words, the Fed is keeping all its options open.

“I would also point out that, while the median of the dots still indicates two rate cuts this year, the mean has shifted clearly in a hawkish direction, toward one rate cut only.

“Several Federal Open Market Committee members clearly acknowledge that it would be especially risky to cut rates given the possibility that inflation might reaccelerate. Moreover, the Fed does not think that a significant growth slowdown should be taken for granted yet, for two reasons.

“First, that while surveys have recorded weaker consumer confidence, hard data show the US economy is still in good shape, with a solid pace of economic activity and the labor market in a “low hiring, low firing” equilibrium with a still low unemployment rate.

“Second, that the macro outlook will depend on the administration’s entire economic policy package, including not just tariffs and immigration, but also fiscal policy and deregulation.

“Unsrprisingly, I agree on both counts, as I have pointed out earlier that, while tariffs and immigration have come up-front, concrete action on deregulation and tax policy is expected to follow, and these are the two elements that should help lift growth and contain inflation.

“The key issue right now is that “uncertainty is remarkably high,” as Powell put it—the fog of trade war. The question is how to handle it.

“For the Fed, as for private companies, the key question is how long to wait before taking action. The Fed is, in a way, forced to wait longer, even at the risk of finding itself behind the curve. Not knowing yet whether the risks will be skewed toward significantly lower growth or sharply higher inflation makes it much harder for the Fed to act pre-emptively on rates.

“For companies, the defensive strategy is to cut back on investment first, and then on employment. As long as there is a good prospect of pro-growth policies kicking in, companies have reason to wait, so as not to miss out on the upside. The longer we go with volatile threats of tariffs and no concrete progress on deregulation and taxes, the more companies will need to worry about the slower growth scenario and will be tempted to pull back.

“Equity markets rallied after the Fed’s press conference, but perhaps for the wrong reason. I don’t see the Fed as turning more dovish. I have argued for some time that inflation pressures are set to remain elevated above the Fed’s comfort zone. If higher tariffs compound these pressures, the Fed will have to think twice about any further rate cuts. And if growth slows significantly at the same time, the Fed might find it has run out of silver bullets.

“Downside risks and flagging sentiment bear watching; the longer the uncertainty, the higher the risk. But the reason to be more optimistic on the outlook is that growth is still solid and pro-growth policy measures are still in the cards. Therefore, I am still sticking to my call for at most one rate cut this year, with some probability of none.”

]]>

Sonal Desai

Sonal Desai, Chief Investment Officer, Franklin Templeton Fixed Income believes markets have been excessively worried about stagflation risk and are now too confident that the Fed would rush to support growth even if inflation turns back to a rising path.

“Financial markets saw this week’s Federal Reserve (Fed) policy meeting as dovish. I’m not so sure. The Fed now projects slower growth and higher inflation compared to its December forecasts. The reduction in expected growth is meaningful, by 0.4 percentage point (pp) this year and 0.2 pp next year—though the unemployment forecast is virtually unchanged, with a mere 0.1 pp uptick for this year, probably reflecting tighter immigration policy. Core personal consumption expenditure inflation has been revised higher by 0.3 pp this year, but with no change for 2026 and 2027. In other words, the likely bump in inflation caused by tariffs is expected to be, yes, transitory. Some reporters baited Fed Chair Jerome Powell on the “transitory” label, which became infamous after the persistent inflation of 2021-2024. This time, however, there are solid reasons to expect that an acceleration in inflation would not last. Unlike in the post-pandemic period, the supply shock (from tariffs, in this case) is not expected to be validated by a massive expansion in government expenditures.

“On policy interest rates, the median of the “dots” still signals two rate cuts this year, the same as last December. That’s why most investors saw this as a dovish shift: The Fed projects higher inflation but still intends to cut rates, and by the same amount as previously.

“I disagree with this interpretation. Powell explained that, first, the Fed’s baseline expectation for now is a temporary shock to inflation, which the central bank would rightly look through; but second, more importantly, the main reason why the policy forecast is unchanged is that policy uncertainty is now so high that the Fed cannot yet predict with any confidence whether it will need to keep rates higher or lower. In other words, the Fed is keeping all its options open.

“I would also point out that, while the median of the dots still indicates two rate cuts this year, the mean has shifted clearly in a hawkish direction, toward one rate cut only.

“Several Federal Open Market Committee members clearly acknowledge that it would be especially risky to cut rates given the possibility that inflation might reaccelerate. Moreover, the Fed does not think that a significant growth slowdown should be taken for granted yet, for two reasons.

“First, that while surveys have recorded weaker consumer confidence, hard data show the US economy is still in good shape, with a solid pace of economic activity and the labor market in a “low hiring, low firing” equilibrium with a still low unemployment rate.

“Second, that the macro outlook will depend on the administration’s entire economic policy package, including not just tariffs and immigration, but also fiscal policy and deregulation.

“Unsrprisingly, I agree on both counts, as I have pointed out earlier that, while tariffs and immigration have come up-front, concrete action on deregulation and tax policy is expected to follow, and these are the two elements that should help lift growth and contain inflation.

“The key issue right now is that “uncertainty is remarkably high,” as Powell put it—the fog of trade war. The question is how to handle it.

“For the Fed, as for private companies, the key question is how long to wait before taking action. The Fed is, in a way, forced to wait longer, even at the risk of finding itself behind the curve. Not knowing yet whether the risks will be skewed toward significantly lower growth or sharply higher inflation makes it much harder for the Fed to act pre-emptively on rates.

“For companies, the defensive strategy is to cut back on investment first, and then on employment. As long as there is a good prospect of pro-growth policies kicking in, companies have reason to wait, so as not to miss out on the upside. The longer we go with volatile threats of tariffs and no concrete progress on deregulation and taxes, the more companies will need to worry about the slower growth scenario and will be tempted to pull back.

“Equity markets rallied after the Fed’s press conference, but perhaps for the wrong reason. I don’t see the Fed as turning more dovish. I have argued for some time that inflation pressures are set to remain elevated above the Fed’s comfort zone. If higher tariffs compound these pressures, the Fed will have to think twice about any further rate cuts. And if growth slows significantly at the same time, the Fed might find it has run out of silver bullets.

“Downside risks and flagging sentiment bear watching; the longer the uncertainty, the higher the risk. But the reason to be more optimistic on the outlook is that growth is still solid and pro-growth policy measures are still in the cards. Therefore, I am still sticking to my call for at most one rate cut this year, with some probability of none.”

The post The fog of trade war and why Franklin Templeton is calling for at most one rate cut this year, with some probability of none appeared first on AdviserVoice.

]]> https://www.adviservoice.com.au/2025/03/the-fog-of-trade-war-and-why-franklin-templeton-is-calling-for-at-most-one-rate-cut-this-year-with-some-probability-of-none/feed/ 0 Markets getting wobbly? https://www.adviservoice.com.au/2025/03/markets-getting-wobbly/ https://www.adviservoice.com.au/2025/03/markets-getting-wobbly/#respond Wed, 05 Mar 2025 20:10:28 +0000 https://www.adviservoice.com.au/?p=101689

Sonal Desai

Franklin Templeton processes the signals

The new US administration has started off with a whirlwind of actions, plans and ideas, which in turn have generated a frenzy of reactions both at home and abroad. All this has resulted in a lot of information to process and a lot of noise to filter out. As a consequence, assessing the balance of risks to the macroeconomic environment has become especially hard.

Franklin Templeton Fixed Income CIO Sonal Desai shifts through the noise and reflects on the new US administration’s plans, ideas and actions so far, and what they might mean for the US economy and fixed income investors.

“Two of the administration’s early lines of action have the potential to cause significant disruption, and this in turn has fuelled fears of an adverse impact on economic activity. Tariff threats are the most obvious example, as they could lead companies to postpone investment while they figure out how they might need to reconfigure their supply chains or absorb higher input costs. The second is cuts in public expenditure and employment driven by the new Department of Government Efficiency (DOGE). These have raised the fear of curtailments in public services as well as a direct negative hit to overall employment.

“We have seen some signs of weakness in recent data. Of particular concern is the decline in January consumer confidence recorded by both the University of Michigan and the Conference Board,” notes Desai.

A deceleration in consumer spending has accompanied the drop in confidence, and it contributed to a downgrade in expected first quarter growth by the Atlanta Federal Reserve (Fed), although the main driver by far was an acceleration in imports. The disappointing February ISM manufacturing data also suggests a weaker start in the new year.

“The key underlying issue, in my view, is the sequencing of policy measures. Most of the action so far has been focused on tariffs and on DOGE. We have seen less concrete progress on deregulation and tax cuts, the two areas that hold the key to boosting economic growth while containing inflation.

“As a consequence, for the moment, households and businesses are feeling heightened uncertainty (predictably played up by the media), little relief on price pressures, since inflation remains elevated, and no definite good news on taxes.

“But we must remember that it’s early days; this administration has been in office for barely over a month. The immediate focus on cost cuts and personnel changes throughout government agencies in itself makes it hard to simultaneously move forward with deregulation. It is disrupting the very same agencies responsible for reforming the regulatory frameworks in their respective areas. This delay in deregulation efforts is disappointing, but we do not yet have reason to doubt the administration’s commitment in this regard. President Trump has often emphasised that lightening the regulatory burden is a priority, and the track record of his first term confirms it. Also, the decisive approach of DOGE to making the bureaucracy leaner and more efficient seems to portend a similar attitude toward regulation.”

Meanwhile, the House and Senate have recently passed two different budget bills that include substantial tax cuts as well as planned spending reductions. Progress on this front will be harder and will need more time. Congress and the administration need to reconcile ambitious tax-cut goals with the need to reduce the budget deficit to more manageable proportions than the 6%‒7% of gross domestic product average of the last several years. Since cuts to Social Security and Medicare seem to be off the table, achieving appropriate spending cuts will be hard, so that agreement on a new fiscal framework will require a lot more work.

“Some help will come from DOGE, which appears to be making steady progress in identifying government expenditures of questionable value. This is hardly surprising. Last year, the Government Accountability Office estimated about US $240 billion in improper payments in fiscal year 2023, and a cumulative US $2.7 trillion over the past ten years. (Improper payments are defined as overpayments, payments made to ineligible people or entities, and, in some cases, fraud.) There is definitely room for savings. However, what we’ve seen so far does not change my view that it’s going to be hard to put US fiscal policy on a sounder long-term trajectory without addressing entitlements. DOGE can help the budget and support stronger growth through a more efficient public sector, but it won’t solve the long-term fiscal challenge, which remains a crucial policy issue for both the president and Congress to tackle.

“On balance, the new US administration is still moving in the direction of growth-enhancing policy changes. The accompanying uncertainty poses some risks, and we need to keep a close eye on both confidence measures and activity indicators. I mentioned above the recent drop in consumer confidence, which causes some concern. On the other hand, the Conference Board also recorded a sharp increase in CEO confidence, which remains a strong show of optimism in the economic outlook. And while personal consumption decelerated in January, we saw a similar deceleration in January last year, and it was followed by a healthy rise through 2024.

“Overall, economic activity remains resilient, and the labor market is still in very good shape. Concerns about the potential negative impact of tariffs on growth are reasonable but should not be exaggerated: the United States is a large and mostly closed economy, and trade has a limited effect on growth. We need to be watchful, but pessimism would be very premature, in my view.

“I still expect that the US economy will grow above its potential this year.

“I also still expect inflation pressures to remain resilient, with headline inflation to end the year around current levels. And as the Fed has already signaled caution and identified tariffs as a potential inflation risk, I still believe the current easing cycle might be over or nearly over, even if markets have recently moved to price two additional rate cuts instead of just one.

“A slowdown in economic activity might mitigate at the margin the upward pressures on bond yields, but not by much, especially if fiscal policy remains as loose as it currently is. I still expect the 10-year US Treasury yield to be in the 4.75%-5% range by year-end, but lack of progress on deregulation could keep us closer to the lower end of my narrow range. Conversely, a significant further expansion in the budget deficit could push yields above the 5% threshold.

“We can expect noise and volatility to remain elevated. But the one thing we should be watching closely in the coming weeks is progress on tax reform and on deregulation, with its attendant positive jolt to confidence, because these are the keys to a sustainably strong growth outlook,” noted Desai.

Ends

Please contact Simrita Virk (simrita@capitaloutcomes.co) for any media queries.

About Franklin Templeton

Franklin Resources, Inc. [NYSE:BEN] is a global investment management organisation with subsidiaries operating as Franklin Templeton and serving clients in over 150 countries. Franklin Templeton’s mission is to help clients achieve better outcomes through investment management expertise, wealth management and technology solutions. Through its specialist investment managers, the company offers specialisation on a global scale, bringing extensive capabilities in fixed income, equity, alternatives and multi-asset solutions. With more than 1,500 investment professionals, and offices in major financial markets around the world, the California-based company has over 75 years of investment experience and A$2.5 trillion in assets under management as of September 30, 2024.

For more information, please visit www.franklinresources.com and follow us on LinkedIn, Twitter and Facebook.

This publication is for information only and does not constitute investment advice or a recommendation and was prepared without regard to the specific objectives, financial situation or needs of any particular person who may receive it. This document may not be reproduced, distributed or published without prior written permission from Franklin Templeton.

Any research and analysis contained in this document has been procured by Franklin Templeton for its own purposes and may be acted upon in that connection and, as such, is provided to you incidentally. Although information has been obtained from sources that Franklin Templeton believes to be reliable, no guarantee can be given as to its accuracy and such information may be incomplete or condensed and may be subject to change at any time without notice. Any views expressed are the views of the fund manager as of the date of this document and do not constitute investment advice. The underlying assumptions and these views are subject to change based on market and other conditions and may differ from other portfolio managers or of the firm as a whole.

There is no assurance that any prediction, projection or forecast on the economy, stock market, bond market or the economic trends of the markets will be realized. Franklin Templeton accepts no liability whatsoever for any direct or indirect consequential loss arising from the use of any information, opinion or estimate herein.

The value of investments and the income from them can go down as well as up and you may not get back the full amount that you invested. Past performance is not necessarily indicative nor a guarantee of future performance.

Issued by Franklin Templeton Australia Limited (ABN 76 004 835 849, AFSL 240827).

Copyright © 2025Franklin Templeton. All rights reserved.

]]>

Sonal Desai

Franklin Templeton processes the signals

The new US administration has started off with a whirlwind of actions, plans and ideas, which in turn have generated a frenzy of reactions both at home and abroad. All this has resulted in a lot of information to process and a lot of noise to filter out. As a consequence, assessing the balance of risks to the macroeconomic environment has become especially hard.

Franklin Templeton Fixed Income CIO Sonal Desai shifts through the noise and reflects on the new US administration’s plans, ideas and actions so far, and what they might mean for the US economy and fixed income investors.

“Two of the administration’s early lines of action have the potential to cause significant disruption, and this in turn has fuelled fears of an adverse impact on economic activity. Tariff threats are the most obvious example, as they could lead companies to postpone investment while they figure out how they might need to reconfigure their supply chains or absorb higher input costs. The second is cuts in public expenditure and employment driven by the new Department of Government Efficiency (DOGE). These have raised the fear of curtailments in public services as well as a direct negative hit to overall employment.

“We have seen some signs of weakness in recent data. Of particular concern is the decline in January consumer confidence recorded by both the University of Michigan and the Conference Board,” notes Desai.

A deceleration in consumer spending has accompanied the drop in confidence, and it contributed to a downgrade in expected first quarter growth by the Atlanta Federal Reserve (Fed), although the main driver by far was an acceleration in imports. The disappointing February ISM manufacturing data also suggests a weaker start in the new year.

“The key underlying issue, in my view, is the sequencing of policy measures. Most of the action so far has been focused on tariffs and on DOGE. We have seen less concrete progress on deregulation and tax cuts, the two areas that hold the key to boosting economic growth while containing inflation.

“As a consequence, for the moment, households and businesses are feeling heightened uncertainty (predictably played up by the media), little relief on price pressures, since inflation remains elevated, and no definite good news on taxes.

“But we must remember that it’s early days; this administration has been in office for barely over a month. The immediate focus on cost cuts and personnel changes throughout government agencies in itself makes it hard to simultaneously move forward with deregulation. It is disrupting the very same agencies responsible for reforming the regulatory frameworks in their respective areas. This delay in deregulation efforts is disappointing, but we do not yet have reason to doubt the administration’s commitment in this regard. President Trump has often emphasised that lightening the regulatory burden is a priority, and the track record of his first term confirms it. Also, the decisive approach of DOGE to making the bureaucracy leaner and more efficient seems to portend a similar attitude toward regulation.”

Meanwhile, the House and Senate have recently passed two different budget bills that include substantial tax cuts as well as planned spending reductions. Progress on this front will be harder and will need more time. Congress and the administration need to reconcile ambitious tax-cut goals with the need to reduce the budget deficit to more manageable proportions than the 6%‒7% of gross domestic product average of the last several years. Since cuts to Social Security and Medicare seem to be off the table, achieving appropriate spending cuts will be hard, so that agreement on a new fiscal framework will require a lot more work.

“Some help will come from DOGE, which appears to be making steady progress in identifying government expenditures of questionable value. This is hardly surprising. Last year, the Government Accountability Office estimated about US $240 billion in improper payments in fiscal year 2023, and a cumulative US $2.7 trillion over the past ten years. (Improper payments are defined as overpayments, payments made to ineligible people or entities, and, in some cases, fraud.) There is definitely room for savings. However, what we’ve seen so far does not change my view that it’s going to be hard to put US fiscal policy on a sounder long-term trajectory without addressing entitlements. DOGE can help the budget and support stronger growth through a more efficient public sector, but it won’t solve the long-term fiscal challenge, which remains a crucial policy issue for both the president and Congress to tackle.

“On balance, the new US administration is still moving in the direction of growth-enhancing policy changes. The accompanying uncertainty poses some risks, and we need to keep a close eye on both confidence measures and activity indicators. I mentioned above the recent drop in consumer confidence, which causes some concern. On the other hand, the Conference Board also recorded a sharp increase in CEO confidence, which remains a strong show of optimism in the economic outlook. And while personal consumption decelerated in January, we saw a similar deceleration in January last year, and it was followed by a healthy rise through 2024.

“Overall, economic activity remains resilient, and the labor market is still in very good shape. Concerns about the potential negative impact of tariffs on growth are reasonable but should not be exaggerated: the United States is a large and mostly closed economy, and trade has a limited effect on growth. We need to be watchful, but pessimism would be very premature, in my view.

“I still expect that the US economy will grow above its potential this year.

“I also still expect inflation pressures to remain resilient, with headline inflation to end the year around current levels. And as the Fed has already signaled caution and identified tariffs as a potential inflation risk, I still believe the current easing cycle might be over or nearly over, even if markets have recently moved to price two additional rate cuts instead of just one.

“A slowdown in economic activity might mitigate at the margin the upward pressures on bond yields, but not by much, especially if fiscal policy remains as loose as it currently is. I still expect the 10-year US Treasury yield to be in the 4.75%-5% range by year-end, but lack of progress on deregulation could keep us closer to the lower end of my narrow range. Conversely, a significant further expansion in the budget deficit could push yields above the 5% threshold.

“We can expect noise and volatility to remain elevated. But the one thing we should be watching closely in the coming weeks is progress on tax reform and on deregulation, with its attendant positive jolt to confidence, because these are the keys to a sustainably strong growth outlook,” noted Desai.

Ends

Please contact Simrita Virk (simrita@capitaloutcomes.co) for any media queries.

About Franklin Templeton

Franklin Resources, Inc. [NYSE:BEN] is a global investment management organisation with subsidiaries operating as Franklin Templeton and serving clients in over 150 countries. Franklin Templeton’s mission is to help clients achieve better outcomes through investment management expertise, wealth management and technology solutions. Through its specialist investment managers, the company offers specialisation on a global scale, bringing extensive capabilities in fixed income, equity, alternatives and multi-asset solutions. With more than 1,500 investment professionals, and offices in major financial markets around the world, the California-based company has over 75 years of investment experience and A$2.5 trillion in assets under management as of September 30, 2024.

For more information, please visit www.franklinresources.com and follow us on LinkedIn, Twitter and Facebook.

This publication is for information only and does not constitute investment advice or a recommendation and was prepared without regard to the specific objectives, financial situation or needs of any particular person who may receive it. This document may not be reproduced, distributed or published without prior written permission from Franklin Templeton.

Any research and analysis contained in this document has been procured by Franklin Templeton for its own purposes and may be acted upon in that connection and, as such, is provided to you incidentally. Although information has been obtained from sources that Franklin Templeton believes to be reliable, no guarantee can be given as to its accuracy and such information may be incomplete or condensed and may be subject to change at any time without notice. Any views expressed are the views of the fund manager as of the date of this document and do not constitute investment advice. The underlying assumptions and these views are subject to change based on market and other conditions and may differ from other portfolio managers or of the firm as a whole.

There is no assurance that any prediction, projection or forecast on the economy, stock market, bond market or the economic trends of the markets will be realized. Franklin Templeton accepts no liability whatsoever for any direct or indirect consequential loss arising from the use of any information, opinion or estimate herein.

The value of investments and the income from them can go down as well as up and you may not get back the full amount that you invested. Past performance is not necessarily indicative nor a guarantee of future performance.

Issued by Franklin Templeton Australia Limited (ABN 76 004 835 849, AFSL 240827).

Copyright © 2025Franklin Templeton. All rights reserved.

The post Markets getting wobbly? appeared first on AdviserVoice.

]]> https://www.adviservoice.com.au/2025/03/markets-getting-wobbly/feed/ 0 Two driving forces will continue to push higher long-term real interest rate https://www.adviservoice.com.au/2024/05/two-driving-forces-will-continue-to-push-higher-long-term-real-interest-rate/ https://www.adviservoice.com.au/2024/05/two-driving-forces-will-continue-to-push-higher-long-term-real-interest-rate/#respond Wed, 29 May 2024 21:40:21 +0000 https://www.adviservoice.com.au/?p=95999

Sonal Desai

According to Franklin Templeton Fixed Income CIO Sonal Desai rising investment and persistently loose US fiscal policy are simultaneously pushing in the direction of higher long-term real interest rates.

“While investors and commentators often tend to conflate the two, I think it is useful instead to distinguish them clearly. They are rising investment, and persistently large fiscal deficits,” says Desai.

“A new trend toward stronger investment has emerged and is likely to endure for the next several years, driven by a number of important priorities: (a) there is a need to make up for past under-investment in infrastructure, including traditional infrastructure as well as digital infrastructure. The American Society of Civil Engineers’ latest report assigns a failing grade to overall US infrastructure (not for the first time)1; (b) rising geopolitical tensions necessitate an increase in defense spending across Western countries; (c) growing interest in the potential of Artificial Intelligence calls for new investment in the necessary hardware (notably semiconductors), software and energy; (d) the green energy transition requires more investment to boost the role of renewables; and (e) manufacturing companies need to continue to invest in new technologies, which includes making supply chains more resilient.

“Not all of this will result in rapid gains in productivity. For example, while the green energy transition is a very important goal, a lot of the required investment will not increase productivity growth in the short and medium run. Because it consists of replacing existing capital, it increases current economic growth via higher expenditures, but it does not raise productivity—much like rebuilding existing structures after they’ve been destroyed by a hurricane.

“The economist Jean Pisani-Ferry, in a recent report for the French government, has estimated that in fact investment in the green transition will likely reduce productivity growth by a quarter percentage point per year for the next several years. (The report also warns that the green transition increases inflation risks over the next decade)2.

“However, the bulk of investment should over time result in faster productivity growth (the acceleration in US productivity during 2023 already gives hope, even if the weak first quarter of this year counsels caution). Faster productivity growth should in turn drive faster real economic growth, reversing one of the key arguments of the Secular Stagnation theory3, and implying a higher equilibrium interest rate in the long run.

“Moreover, for a given level of savings, stronger investment also eliminates or reduces the “savings glut,” again pointing to higher real interest rates.

“The government has and will carry out some of this, and investment is therefore often mentioned in the same breath as wider fiscal deficits. But the two need not go hand in hand. Governments could offset stronger public investment with a reduction in less productive public spending (or with higher taxes). Moreover, a significant portion of governments’ investment often turns out to be ineffective at raising productivity—the private sector has consistently been a much better allocator of capital,” notes Desai.

The United States has experienced a persistent loosening of fiscal policy that goes well beyond the country’s public investment efforts. Therefore, quite separately from lifting investment, persistent large fiscal deficits now play their own important role in shaping the outlook for interest rates.

The US government has been running a massively loose fiscal policy for a very long time now: The US fiscal deficit has averaged close to 8% of gross domestic product (GDP) for the last six years. It averaged just under 6% of GDP during 2022-2023 even as economic growth boomed, and the Congressional Budget Office (CBO) projects the deficit to average 5.5% of GDP for the next five years and then to rise further into the future. As a consequence of persistent large deficits, the debt stock has risen sharply.

A decade ago, publicly held federal debt was about 70%; now it is close to 100% of GDP and will keep rising rapidly if deficits remain as large as the CBO forecasts.

Desai says “The need to fund large fiscal deficits year after year means a lot of pressure on bond supply. For a given level of demand, this tends to push bond prices down and interest rates up. Moreover, a large fiscal deficit, growing debt and high interest rates create a vicious spiral that makes it harder and harder to reduce the deficit. Currently, non-defense discretionary expenditures account for less than one-sixth of the US budget (15% of total expenditures). Interest expenditures meanwhile keep rising—they averaged just 1.5 % of GDP in the last 10 years. The CBO projects that they will average 3.5 % of GDP for the next 10 years, more than double, and will grow larger than non-defense discretionary spending by 2025. This would leave very few resources for education, infrastructure investment, transportation, homeland security and the like.

“And the underlying CBO forecasts are probably conservative: They assume that the interest rate on federal debt will remain under 3.5% over the next decade. To put this assumption in perspective, consider that through the 1990s up to the eve of the global financial crisis (GFC)—in other words before the more recent period of ultra-loose monetary policy—the interest rate on US government debt averaged close to 6%. If the average interest rate on debt were to rise even just one percentage point above the CBO assumption (still well below the pre-GFC average), within 10 years interest expenditures would be more than double their current level.

“Any way you cut it, bringing the US budget deficit under control will require very serious efforts, which in my view seems implausible in the current political climate. Meanwhile, loose fiscal policy will likely continue to put upward pressure on interest rates.

“I have been arguing for some time that equilibrium real interest rates are likely much higher than the markets and the Federal Reserve (Fed) still seem to assume—with the neutral fed funds rate above 4% rather than at the Fed’s current forecast of about 2.5%, and 10-year US Treasury yields correspondingly higher. The confluence of loose fiscal policy and a rising investment trend can only strengthen my conviction in this higher interest rates outlook.”

Endnotes

  1. Source: “2021 Report Card for America’s Infrastructure.” American Society of Civil Engineers, 2021.
  2. Source: Pisani-Ferry, Jean and Mahfouz, Selma. “The economic implications of climate action.”   Republique Francaise. November 2023. There is no assurance that any estimate, forecast or projection will be realized.
  3. Secular Stagnation theory suggests that an economy can experience persistent low GDP growth, low interest rates, and high long-term unemployment due to a deficiency in aggregate demand.

 

]]>

Sonal Desai

According to Franklin Templeton Fixed Income CIO Sonal Desai rising investment and persistently loose US fiscal policy are simultaneously pushing in the direction of higher long-term real interest rates.

“While investors and commentators often tend to conflate the two, I think it is useful instead to distinguish them clearly. They are rising investment, and persistently large fiscal deficits,” says Desai.

“A new trend toward stronger investment has emerged and is likely to endure for the next several years, driven by a number of important priorities: (a) there is a need to make up for past under-investment in infrastructure, including traditional infrastructure as well as digital infrastructure. The American Society of Civil Engineers’ latest report assigns a failing grade to overall US infrastructure (not for the first time)1; (b) rising geopolitical tensions necessitate an increase in defense spending across Western countries; (c) growing interest in the potential of Artificial Intelligence calls for new investment in the necessary hardware (notably semiconductors), software and energy; (d) the green energy transition requires more investment to boost the role of renewables; and (e) manufacturing companies need to continue to invest in new technologies, which includes making supply chains more resilient.

“Not all of this will result in rapid gains in productivity. For example, while the green energy transition is a very important goal, a lot of the required investment will not increase productivity growth in the short and medium run. Because it consists of replacing existing capital, it increases current economic growth via higher expenditures, but it does not raise productivity—much like rebuilding existing structures after they’ve been destroyed by a hurricane.

“The economist Jean Pisani-Ferry, in a recent report for the French government, has estimated that in fact investment in the green transition will likely reduce productivity growth by a quarter percentage point per year for the next several years. (The report also warns that the green transition increases inflation risks over the next decade)2.

“However, the bulk of investment should over time result in faster productivity growth (the acceleration in US productivity during 2023 already gives hope, even if the weak first quarter of this year counsels caution). Faster productivity growth should in turn drive faster real economic growth, reversing one of the key arguments of the Secular Stagnation theory3, and implying a higher equilibrium interest rate in the long run.

“Moreover, for a given level of savings, stronger investment also eliminates or reduces the “savings glut,” again pointing to higher real interest rates.

“The government has and will carry out some of this, and investment is therefore often mentioned in the same breath as wider fiscal deficits. But the two need not go hand in hand. Governments could offset stronger public investment with a reduction in less productive public spending (or with higher taxes). Moreover, a significant portion of governments’ investment often turns out to be ineffective at raising productivity—the private sector has consistently been a much better allocator of capital,” notes Desai.

The United States has experienced a persistent loosening of fiscal policy that goes well beyond the country’s public investment efforts. Therefore, quite separately from lifting investment, persistent large fiscal deficits now play their own important role in shaping the outlook for interest rates.

The US government has been running a massively loose fiscal policy for a very long time now: The US fiscal deficit has averaged close to 8% of gross domestic product (GDP) for the last six years. It averaged just under 6% of GDP during 2022-2023 even as economic growth boomed, and the Congressional Budget Office (CBO) projects the deficit to average 5.5% of GDP for the next five years and then to rise further into the future. As a consequence of persistent large deficits, the debt stock has risen sharply.

A decade ago, publicly held federal debt was about 70%; now it is close to 100% of GDP and will keep rising rapidly if deficits remain as large as the CBO forecasts.

Desai says “The need to fund large fiscal deficits year after year means a lot of pressure on bond supply. For a given level of demand, this tends to push bond prices down and interest rates up. Moreover, a large fiscal deficit, growing debt and high interest rates create a vicious spiral that makes it harder and harder to reduce the deficit. Currently, non-defense discretionary expenditures account for less than one-sixth of the US budget (15% of total expenditures). Interest expenditures meanwhile keep rising—they averaged just 1.5 % of GDP in the last 10 years. The CBO projects that they will average 3.5 % of GDP for the next 10 years, more than double, and will grow larger than non-defense discretionary spending by 2025. This would leave very few resources for education, infrastructure investment, transportation, homeland security and the like.

“And the underlying CBO forecasts are probably conservative: They assume that the interest rate on federal debt will remain under 3.5% over the next decade. To put this assumption in perspective, consider that through the 1990s up to the eve of the global financial crisis (GFC)—in other words before the more recent period of ultra-loose monetary policy—the interest rate on US government debt averaged close to 6%. If the average interest rate on debt were to rise even just one percentage point above the CBO assumption (still well below the pre-GFC average), within 10 years interest expenditures would be more than double their current level.

“Any way you cut it, bringing the US budget deficit under control will require very serious efforts, which in my view seems implausible in the current political climate. Meanwhile, loose fiscal policy will likely continue to put upward pressure on interest rates.

“I have been arguing for some time that equilibrium real interest rates are likely much higher than the markets and the Federal Reserve (Fed) still seem to assume—with the neutral fed funds rate above 4% rather than at the Fed’s current forecast of about 2.5%, and 10-year US Treasury yields correspondingly higher. The confluence of loose fiscal policy and a rising investment trend can only strengthen my conviction in this higher interest rates outlook.”

Endnotes

  1. Source: “2021 Report Card for America’s Infrastructure.” American Society of Civil Engineers, 2021.
  2. Source: Pisani-Ferry, Jean and Mahfouz, Selma. “The economic implications of climate action.”   Republique Francaise. November 2023. There is no assurance that any estimate, forecast or projection will be realized.
  3. Secular Stagnation theory suggests that an economy can experience persistent low GDP growth, low interest rates, and high long-term unemployment due to a deficiency in aggregate demand.

 

The post Two driving forces will continue to push higher long-term real interest rate appeared first on AdviserVoice.

]]> https://www.adviservoice.com.au/2024/05/two-driving-forces-will-continue-to-push-higher-long-term-real-interest-rate/feed/ 0 Fed’s sticky wicket as investors brace for more volatility https://www.adviservoice.com.au/2024/02/feds-sticky-wicket-as-investors-brace-for-more-volatility/ https://www.adviservoice.com.au/2024/02/feds-sticky-wicket-as-investors-brace-for-more-volatility/#respond Mon, 19 Feb 2024 20:40:50 +0000 https://www.adviservoice.com.au/?p=93983

Sonal Desai

Franklin Templeton’s Fixed Income Chief Investment Officer Sonal Desai says January inflation print confirms that the “last mile” of disinflation may prove to be a lot harder than markets expect, and investors should brace for more volatility and a possible move of 10-year Treasury yields back in the 4.25%-4.50% range.

Desai notes “January’s US inflation print came as an unwelcome spoiler for financial markets, dealing what looks like the final blow to hopes of a March interest-rate cut, sending bond yields back up and triggering a major one-day correction in equities.

“First, let’s put all this in perspective. Headline year-over-year inflation still came down—to 3.1% from December’s 3.4%—though remaining above the expected 2.9%. And the equity market correction, while a significant one-day move, still leaves in place the upward trend seen since October.

“Having said this, there is a lot in January’s inflation report to support my long-held view that the “last mile” of disinflation is going to be a lot harder than markets expect, the Federal Reserve (Fed) will need to be very patient on monetary easing, and the new equilibrium we’re trending to will have markedly higher rates than we’ve been used to in the pre-inflation surge period.

“Start with “supercore” inflation, i.e., the price of services excluding energy and housing.

“The Fed has highlighted this as the measure that is likely most representative of underlying inflation trends and most sensitive to wage pressures. It was up 0.9% month-on-month, marking three continuous months of acceleration and the fastest pace of increase since April 2022. The acceleration was driven by medical services, recreation, education, communication, hotels, airfare and other intercity transportation—a rather wide range of categories. On a year-on-year basis, the supercore index change is well above 4%. More worrying still, on a six-month annualized basis, supercore inflation is now up 5.5%—not seen since late 2022.

“Looking at shelter, this component has been considered a reliable source of ongoing future disinflation, with the expectation that cheaper rental contracts feed into the inflation statistics with a lag. Here, we might be in for another disappointment. Owner-occupied rent accelerated in January.

“Moreover, my colleague Nikhil Mohan, economist and research analyst, Franklin Fixed Income, has highlighted that since early 2021, rents as measured in the personal consumption expenditures (PCE) have diverged substantially from rents as measured in the Zillow Observed Rent Index.

“In recent months, the increase in Zillow-measured rents has slowed, whereas the rent component in PCE keeps rising steadily, in a gradual catch-up. As you can see from the chart, PCE rents have a ways to go to close the gap with rent observed in Zillow. If a catch-up is indeed what is going on, we might still have quite a bit of pent-up inflation pressure in the rental cost component of inflation and therefore shelter might not contribute as much to disinflation as generally assumed.

“Core goods prices declined for the third consecutive month. This is good news, confirming that the surge in core goods was largely transitory, and seems to be reversing with the normalisation of supply chains.

“Looking forward, however, I think we would do well to keep in mind three points:

  • The US economy is obviously in rude health. We’ve seen strong numbers on the labor market, continued robust increases in wages, and upside surprises on consumer confidence, retail spending and gross domestic product growth. Against this background, it’s hardly surprising that disinflation has stalled. Yes, there was a transitory component due to supply disruptions which are now being resolved. But as I argued from the very beginning, higher inflation pressures partly reflected strong aggregate demand—and that keeps going. Supply has recovered, including with the productivity rebound, but not enough to offset continued strong demand.
  • Supply shocks are not completely out of the picture. Disruptions in the Red Sea have already caused a rise in transportation costs that eventually might be passed on to consumers, and tensions in the Middle East show no sign of abating. And whether you look at China or Russia, geopolitical risks overall appear on the rise.
  • Fiscal policy remains very loose, with very little chance of retrenchment now that we have entered an election year.

“When you combine these three considerations with the signals in the latest inflation prints, the risk that inflation will prove stubborn appears significant—and by the way, measures of sticky inflation that the Cleveland Fed and the Atlanta Fed track send a very similar message. It does not mean a risk of inflation rising anew, forcing the Fed to consider additional hikes. But I think it does imply higher uncertainty on how long it will take before inflation is sustainably back to 2%.

“The Fed has been wise to dampen market enthusiasm in the past few weeks, after having abetted the irrational exuberance of end-2023. To me, the second half of the year remains the most likely time for a first interest-rate cut, and chances that the fed funds rate might fall by more than 75 basis points (bps) this year appear slim. If anything, we might only see a reduction of 50 bps.

“This is not the first time that markets’ fervent hopes of early and large rate cuts have been dashed—and it won’t be the last. Financial markets want to anticipate a significant monetary easing, and I think that when we get the next datapoint, or a Fed official making the next dovish statement, we’ll likely see rate-cut expectations surge again. To be dashed yet again, I would wager. So, brace for continued volatility, and I reiterate my call for 10-year Treasury yields in the 4.25%-4.50% range.

“Finally, the long run: Activity data and inflation numbers all suggest that monetary policy is not too tight at all. In turn, this means that the neutral rate of interest is higher than what the Fed has penciled in and markets keep expecting. Some Fed officials have recently signaled as much, and I have made this point for quite some time, but it bears repeating—the neutral real rate is likely closer to 2% than to the Fed’s 0.5% estimate, and this implies that the neutral fed funds rate is likely closer to 4%. Investors should bear this in mind as they plan their investment strategy for the easing cycle,” says Desai.

]]>

Sonal Desai

Franklin Templeton’s Fixed Income Chief Investment Officer Sonal Desai says January inflation print confirms that the “last mile” of disinflation may prove to be a lot harder than markets expect, and investors should brace for more volatility and a possible move of 10-year Treasury yields back in the 4.25%-4.50% range.

Desai notes “January’s US inflation print came as an unwelcome spoiler for financial markets, dealing what looks like the final blow to hopes of a March interest-rate cut, sending bond yields back up and triggering a major one-day correction in equities.

“First, let’s put all this in perspective. Headline year-over-year inflation still came down—to 3.1% from December’s 3.4%—though remaining above the expected 2.9%. And the equity market correction, while a significant one-day move, still leaves in place the upward trend seen since October.

“Having said this, there is a lot in January’s inflation report to support my long-held view that the “last mile” of disinflation is going to be a lot harder than markets expect, the Federal Reserve (Fed) will need to be very patient on monetary easing, and the new equilibrium we’re trending to will have markedly higher rates than we’ve been used to in the pre-inflation surge period.

“Start with “supercore” inflation, i.e., the price of services excluding energy and housing.

“The Fed has highlighted this as the measure that is likely most representative of underlying inflation trends and most sensitive to wage pressures. It was up 0.9% month-on-month, marking three continuous months of acceleration and the fastest pace of increase since April 2022. The acceleration was driven by medical services, recreation, education, communication, hotels, airfare and other intercity transportation—a rather wide range of categories. On a year-on-year basis, the supercore index change is well above 4%. More worrying still, on a six-month annualized basis, supercore inflation is now up 5.5%—not seen since late 2022.

“Looking at shelter, this component has been considered a reliable source of ongoing future disinflation, with the expectation that cheaper rental contracts feed into the inflation statistics with a lag. Here, we might be in for another disappointment. Owner-occupied rent accelerated in January.

“Moreover, my colleague Nikhil Mohan, economist and research analyst, Franklin Fixed Income, has highlighted that since early 2021, rents as measured in the personal consumption expenditures (PCE) have diverged substantially from rents as measured in the Zillow Observed Rent Index.

“In recent months, the increase in Zillow-measured rents has slowed, whereas the rent component in PCE keeps rising steadily, in a gradual catch-up. As you can see from the chart, PCE rents have a ways to go to close the gap with rent observed in Zillow. If a catch-up is indeed what is going on, we might still have quite a bit of pent-up inflation pressure in the rental cost component of inflation and therefore shelter might not contribute as much to disinflation as generally assumed.

“Core goods prices declined for the third consecutive month. This is good news, confirming that the surge in core goods was largely transitory, and seems to be reversing with the normalisation of supply chains.

“Looking forward, however, I think we would do well to keep in mind three points:

  • The US economy is obviously in rude health. We’ve seen strong numbers on the labor market, continued robust increases in wages, and upside surprises on consumer confidence, retail spending and gross domestic product growth. Against this background, it’s hardly surprising that disinflation has stalled. Yes, there was a transitory component due to supply disruptions which are now being resolved. But as I argued from the very beginning, higher inflation pressures partly reflected strong aggregate demand—and that keeps going. Supply has recovered, including with the productivity rebound, but not enough to offset continued strong demand.
  • Supply shocks are not completely out of the picture. Disruptions in the Red Sea have already caused a rise in transportation costs that eventually might be passed on to consumers, and tensions in the Middle East show no sign of abating. And whether you look at China or Russia, geopolitical risks overall appear on the rise.
  • Fiscal policy remains very loose, with very little chance of retrenchment now that we have entered an election year.

“When you combine these three considerations with the signals in the latest inflation prints, the risk that inflation will prove stubborn appears significant—and by the way, measures of sticky inflation that the Cleveland Fed and the Atlanta Fed track send a very similar message. It does not mean a risk of inflation rising anew, forcing the Fed to consider additional hikes. But I think it does imply higher uncertainty on how long it will take before inflation is sustainably back to 2%.

“The Fed has been wise to dampen market enthusiasm in the past few weeks, after having abetted the irrational exuberance of end-2023. To me, the second half of the year remains the most likely time for a first interest-rate cut, and chances that the fed funds rate might fall by more than 75 basis points (bps) this year appear slim. If anything, we might only see a reduction of 50 bps.

“This is not the first time that markets’ fervent hopes of early and large rate cuts have been dashed—and it won’t be the last. Financial markets want to anticipate a significant monetary easing, and I think that when we get the next datapoint, or a Fed official making the next dovish statement, we’ll likely see rate-cut expectations surge again. To be dashed yet again, I would wager. So, brace for continued volatility, and I reiterate my call for 10-year Treasury yields in the 4.25%-4.50% range.

“Finally, the long run: Activity data and inflation numbers all suggest that monetary policy is not too tight at all. In turn, this means that the neutral rate of interest is higher than what the Fed has penciled in and markets keep expecting. Some Fed officials have recently signaled as much, and I have made this point for quite some time, but it bears repeating—the neutral real rate is likely closer to 2% than to the Fed’s 0.5% estimate, and this implies that the neutral fed funds rate is likely closer to 4%. Investors should bear this in mind as they plan their investment strategy for the easing cycle,” says Desai.

The post Fed’s sticky wicket as investors brace for more volatility appeared first on AdviserVoice.

]]> https://www.adviservoice.com.au/2024/02/feds-sticky-wicket-as-investors-brace-for-more-volatility/feed/ 0 New investment opportunities arise in the changing inflation and growth climate: Franklin Templeton https://www.adviservoice.com.au/2023/08/new-investment-opportunities-arise-in-the-changing-inflation-and-growth-climate-franklin-templeton/ https://www.adviservoice.com.au/2023/08/new-investment-opportunities-arise-in-the-changing-inflation-and-growth-climate-franklin-templeton/#respond Mon, 21 Aug 2023 21:45:55 +0000 https://www.adviservoice.com.au/?p=90805

Stephen Dover

Franklin Templeton, a global investment manager, says that although inflation will continue to be an issue for the next 6–12 months and the global economic recovery is uneven, there are opportunities ahead.

Stephen Dover, chief market strategist at the Franklin Templeton Institute notes “In the first half of 2023, investors faced aggressive US Federal Reserve (Fed) monetary policy tightening, consecutive quarters of falling corporate profits, two of the largest bank failures in US history, a near-default by the US federal government, and universal predictions of US and global recessions.

“With these issues in mind, I moderated a panel of our leading economists including John Bellows, Portfolio Manager, Western Asset; Sonal Desai, Chief Investment Officer, Franklin Templeton Fixed Income; Michael Hasenstab, Chief Investment Officer, Templeton Global Macro; and Francis Scotland, Director of Global Macro Research, Brandywine Global.

“The key question I wanted to address: What’s in store for investors in the second half of 2023?

“Below are my key takeaways from the discussion.

  • Inflation will continue to be an issue for the next 6–12 months. There are some indicators that point to slowing inflation and the global economy entering a period of disinflation, where the rate of inflation is falling and prices are not increasing as rapidly. Failure of inflation to retreat is a risk, and core price inflation has been sticky, but the lagged effects from tighter monetary policy have yet to be fully felt. There is less risk of deflation, where prices actually fall.
  • While inflation is coming down in many countries, the global economic recovery is uneven.
    • China is struggling to find sources of economic growth. An expected surge in growth did not materialize following post-COVID reopening. The Chinese government is likely to step in with more macroeconomic stimulus.
    • Supply-chain rebuilding and friend-shoring should contribute to growth opportunities in some countries. Supply chain rebuilding is leading to increased investment within Asia, particularly in countries like India and Indonesia. Other countries that should benefit include Mexico and Canada.
    • Japan benefited from recent increases in inflation after struggling with low economic growth for decades. The current inflation and growth levels created opportunities to deploy corporate cash balances. Japan also benefited from higher female participation in the labor force that prevented a labor shortage, which in turn supported growth.
  • The upcoming economic data will likely provide further evidence of slowing growth and ongoing disinflation in the US. However, while markets have been anticipating a recession for some time, the strength of the US consumer will likely prevent a massive recession.
  • Where will interest rates settle? There appears to be a disconnect with how fast rates will drop in the future. The financial market is pricing rate cuts with an expectation that inflation returns to pre-pandemic levels. However, we think the 10 years following the 2008 global financial crisis (GFC) were an aberration, and inflation is likely to revert to pre-GFC levels as the long-term norm (core inflation in the US averaged approximately 4% between 1958 and 2008, and just under 2% from 2009 through 2019.)
  • Real interest rates are expected to continue increasing. The Fed just approved another interest rate hike and is expected to hold interest rates above 5% for several more quarters. While inflation is expected to slow or decline over this period, the result is real interest rates (nominal rates minus inflation) rising even if nominal rates do not. This creates a more positive return for investors.
  • New investment opportunities Fixed income investments are resuming status as good portfolio diversifiers. Unlike 2022, where both fixed income and equities had negative returns together, there is now a low correlation between fixed income investments, equities and other risk assets.
    • Selectively increasing duration offers an attractive total return. We see neutral to shorter duration providing better risk/return profiles for the rest of 2023. The current yield levels and the expected peak in interest rates combine for a positive expected total return.
    • High-yield debt is priced attractively as investors remain cautious about the economy. Current yields are providing active investors with high returns. However, investors need to be selective as some lower-quality corporate credit is susceptible to default risk and we have concerns about credit spreads widening.
    • Emerging markets can provide diversification. Many emerging markets have demonstrated strength, partially by controlling debt issuance to a greater extent than their developed market counterparts. They also reacted quickly to bring inflation under control, raising rates ahead of the European Central Bank (ECB) and the Fed. With many emerging market bonds enjoying attractive yields, this asset class provides another source of return that is not necessarily synchronized with the rest of the world.

“While the investor experience for the last six months was extreme volatility in terms of interest rates and changing opportunities, we believe the Fed will continue to bring inflation more fully under control and might hold rates higher for longer than some expect.

“Growth opportunities vary around the world, and across sectors and maturities. Fixed income once again has a low correlation with other risk assets, providing potential diversification and increased portfolio protection.”

Read the paper.

]]>

Stephen Dover

Franklin Templeton, a global investment manager, says that although inflation will continue to be an issue for the next 6–12 months and the global economic recovery is uneven, there are opportunities ahead.

Stephen Dover, chief market strategist at the Franklin Templeton Institute notes “In the first half of 2023, investors faced aggressive US Federal Reserve (Fed) monetary policy tightening, consecutive quarters of falling corporate profits, two of the largest bank failures in US history, a near-default by the US federal government, and universal predictions of US and global recessions.

“With these issues in mind, I moderated a panel of our leading economists including John Bellows, Portfolio Manager, Western Asset; Sonal Desai, Chief Investment Officer, Franklin Templeton Fixed Income; Michael Hasenstab, Chief Investment Officer, Templeton Global Macro; and Francis Scotland, Director of Global Macro Research, Brandywine Global.

“The key question I wanted to address: What’s in store for investors in the second half of 2023?

“Below are my key takeaways from the discussion.

  • Inflation will continue to be an issue for the next 6–12 months. There are some indicators that point to slowing inflation and the global economy entering a period of disinflation, where the rate of inflation is falling and prices are not increasing as rapidly. Failure of inflation to retreat is a risk, and core price inflation has been sticky, but the lagged effects from tighter monetary policy have yet to be fully felt. There is less risk of deflation, where prices actually fall.
  • While inflation is coming down in many countries, the global economic recovery is uneven.
    • China is struggling to find sources of economic growth. An expected surge in growth did not materialize following post-COVID reopening. The Chinese government is likely to step in with more macroeconomic stimulus.
    • Supply-chain rebuilding and friend-shoring should contribute to growth opportunities in some countries. Supply chain rebuilding is leading to increased investment within Asia, particularly in countries like India and Indonesia. Other countries that should benefit include Mexico and Canada.
    • Japan benefited from recent increases in inflation after struggling with low economic growth for decades. The current inflation and growth levels created opportunities to deploy corporate cash balances. Japan also benefited from higher female participation in the labor force that prevented a labor shortage, which in turn supported growth.
  • The upcoming economic data will likely provide further evidence of slowing growth and ongoing disinflation in the US. However, while markets have been anticipating a recession for some time, the strength of the US consumer will likely prevent a massive recession.
  • Where will interest rates settle? There appears to be a disconnect with how fast rates will drop in the future. The financial market is pricing rate cuts with an expectation that inflation returns to pre-pandemic levels. However, we think the 10 years following the 2008 global financial crisis (GFC) were an aberration, and inflation is likely to revert to pre-GFC levels as the long-term norm (core inflation in the US averaged approximately 4% between 1958 and 2008, and just under 2% from 2009 through 2019.)
  • Real interest rates are expected to continue increasing. The Fed just approved another interest rate hike and is expected to hold interest rates above 5% for several more quarters. While inflation is expected to slow or decline over this period, the result is real interest rates (nominal rates minus inflation) rising even if nominal rates do not. This creates a more positive return for investors.
  • New investment opportunities Fixed income investments are resuming status as good portfolio diversifiers. Unlike 2022, where both fixed income and equities had negative returns together, there is now a low correlation between fixed income investments, equities and other risk assets.
    • Selectively increasing duration offers an attractive total return. We see neutral to shorter duration providing better risk/return profiles for the rest of 2023. The current yield levels and the expected peak in interest rates combine for a positive expected total return.
    • High-yield debt is priced attractively as investors remain cautious about the economy. Current yields are providing active investors with high returns. However, investors need to be selective as some lower-quality corporate credit is susceptible to default risk and we have concerns about credit spreads widening.
    • Emerging markets can provide diversification. Many emerging markets have demonstrated strength, partially by controlling debt issuance to a greater extent than their developed market counterparts. They also reacted quickly to bring inflation under control, raising rates ahead of the European Central Bank (ECB) and the Fed. With many emerging market bonds enjoying attractive yields, this asset class provides another source of return that is not necessarily synchronized with the rest of the world.

“While the investor experience for the last six months was extreme volatility in terms of interest rates and changing opportunities, we believe the Fed will continue to bring inflation more fully under control and might hold rates higher for longer than some expect.

“Growth opportunities vary around the world, and across sectors and maturities. Fixed income once again has a low correlation with other risk assets, providing potential diversification and increased portfolio protection.”

Read the paper.

The post New investment opportunities arise in the changing inflation and growth climate: Franklin Templeton appeared first on AdviserVoice.

]]> https://www.adviservoice.com.au/2023/08/new-investment-opportunities-arise-in-the-changing-inflation-and-growth-climate-franklin-templeton/feed/ 0 Inflation and interest rates- have we reached the pivot point? https://www.adviservoice.com.au/2022/02/inflation-and-interest-rates-have-we-reached-the-pivot-point/ https://www.adviservoice.com.au/2022/02/inflation-and-interest-rates-have-we-reached-the-pivot-point/#respond Thu, 10 Feb 2022 20:50:54 +0000 https://adviservoice.com.au/?p=79927 The inflation debate has intensified in recent months.

In the latest edition of Franklin Templeton Investment Institute Macro Perspectives, Franklin Templeton’s investment specialists discuss what’s fueling inflation and how policymakers are combating it. They offer differing views on whether inflation will abate or accelerate as the year progresses.

The paper also explores the potential impacts of the US Federal Reserve’s (Fed’s) pivot on interest rates, Omicron-driven uncertainty, China’s macro playbook, and wage and labor expectations.

Investment Specialist Highlights

Sonal Desai, Chief Investment Officer, Franklin Templeton Fixed Income: “I think the market is being somewhat sanguine about what will happen in the second half of 2022. There is an expectation that inflation will decline sharply. I think that might be optimistic because a lot of the factors driving inflation will still be with us. The Fed is already behind the curve.”

John Bellows, Portfolio Manager, Western Asset: “Our view is that inflation is going to moderate over the next six to 12 months. If there is an environment where expectations are for higher inflation and maybe the Fed is irresponsible in its rhetoric or policy response, that creates a bit of a behavioural self-fulfilling prophecy where people expect higher prices, and businesses raise them.”

Gene Podkaminer, Head of Research, Franklin Templeton Investment Solutions: “Labour supply has not returned in the United States, which is one of the unique aspects about the American economy compared to other developed countries—we would expect the labour shortage to provoke a rise in real wages.”

Michael Hasenstab, Chief Investment Officer, Templeton Global Macro: “Most countries tend to follow the Fed, but in this cycle, we’ve seen substantial rate hikes ahead of the Fed, particularly in Latin America. In Asia, several countries have been able to maintain higher policy rates throughout the pandemic, giving them a buffer against Fed tightening. Certain local-currency valuations within these regions appear highly compelling.”

Francis Scotland, Director of Global Macro Research, Brandywine Global: “Looking at valuations, some emerging market currencies look attractive to us. A lot of emerging markets have been raising interest rates to the point now where they may start to pivot in the other direction. We do see idiosyncratic opportunities popping up across the emerging market space.”

Read the Report.

]]> The inflation debate has intensified in recent months.

In the latest edition of Franklin Templeton Investment Institute Macro Perspectives, Franklin Templeton’s investment specialists discuss what’s fueling inflation and how policymakers are combating it. They offer differing views on whether inflation will abate or accelerate as the year progresses.

The paper also explores the potential impacts of the US Federal Reserve’s (Fed’s) pivot on interest rates, Omicron-driven uncertainty, China’s macro playbook, and wage and labor expectations.

Investment Specialist Highlights

Sonal Desai, Chief Investment Officer, Franklin Templeton Fixed Income: “I think the market is being somewhat sanguine about what will happen in the second half of 2022. There is an expectation that inflation will decline sharply. I think that might be optimistic because a lot of the factors driving inflation will still be with us. The Fed is already behind the curve.”

John Bellows, Portfolio Manager, Western Asset: “Our view is that inflation is going to moderate over the next six to 12 months. If there is an environment where expectations are for higher inflation and maybe the Fed is irresponsible in its rhetoric or policy response, that creates a bit of a behavioural self-fulfilling prophecy where people expect higher prices, and businesses raise them.”

Gene Podkaminer, Head of Research, Franklin Templeton Investment Solutions: “Labour supply has not returned in the United States, which is one of the unique aspects about the American economy compared to other developed countries—we would expect the labour shortage to provoke a rise in real wages.”

Michael Hasenstab, Chief Investment Officer, Templeton Global Macro: “Most countries tend to follow the Fed, but in this cycle, we’ve seen substantial rate hikes ahead of the Fed, particularly in Latin America. In Asia, several countries have been able to maintain higher policy rates throughout the pandemic, giving them a buffer against Fed tightening. Certain local-currency valuations within these regions appear highly compelling.”

Francis Scotland, Director of Global Macro Research, Brandywine Global: “Looking at valuations, some emerging market currencies look attractive to us. A lot of emerging markets have been raising interest rates to the point now where they may start to pivot in the other direction. We do see idiosyncratic opportunities popping up across the emerging market space.”

Read the Report.

The post Inflation and interest rates- have we reached the pivot point? appeared first on AdviserVoice.

]]> https://www.adviservoice.com.au/2022/02/inflation-and-interest-rates-have-we-reached-the-pivot-point/feed/ 0 The rise of regionalisation offers risks and rewards https://www.adviservoice.com.au/2021/10/the-rise-of-regionalisation-offers-risks-and-rewards/ https://www.adviservoice.com.au/2021/10/the-rise-of-regionalisation-offers-risks-and-rewards/#respond Tue, 19 Oct 2021 20:50:29 +0000 https://adviservoice.com.au/?p=77472

Kim Catechis

Investors looking for opportunities in global markets need to pay attention to the post-COVID shift from globalisation to regionalisation, as countries take steps to secure their supply chains and protect their battered economies.

A recent megatrends investment forum hosted by Kim Catechis, investment strategist for the Franklin Templeton Investment Institute, turned its attention to the risk to the globalisation megatrend that has shaped global trade patterns for the past 50 years.

Alastair Reynolds, portfolio manager for Global Emerging Markets Strategies at Martin Currie and panellist at the event, noted: “Globalisation has proved a great boon for emerging market economies over much of the last 50 years, but looking forward, I expect that regional trade patterns will prove more influential than globalisation in determining the fortunes of emerging market companies.

“In the short term, this is likely to be most powerful amongst pan-Asian franchises, as I expect Asia to remain the most dynamic region on a global basis. It might also alter M&A preferences of companies away from seeking global expansion in favour of building regional dominance.

“So, near-neighbour acquisitions in Asia, Europe, Africa and the Americas may be a feature. Regionalisation could be motivated by serving regional preferences in financial services, infrastructure or consumer goods, or its motivations could be more political, such as in guaranteeing supplies of key commodities or inter-operability of technology and communications.

“A move from global ‘just-in-time’ supply chains towards more localised ‘just-in-case’ supply chains will necessitate a new wave of investment in fixed assets, which should be positive for capital goods companies, building materials and industrial real estate. There will also be a one-off step-up in demand as this new supply chain is stocked with inventory.

“However, the increase in activity required to create and stock a more localised supply chain will bring increased costs. Ultimately, someone must bear this cost, and this will present a new test to pricing power throughout industry supply chains.”

Sonal Desai, chief investment officer of Franklin Templeton Fixed Income and another panellist at the forum, added: “Rising protectionism, together with the pandemic, is driving changes in global supply chains and global trade. In the short term, these increase the risk of disruptions and related inflationary pressures.

“In the longer run, they will highlight the importance of well-developed local and regional supply chains, which could become a critical competitive advantage for countries and companies.”

]]>

Kim Catechis

Investors looking for opportunities in global markets need to pay attention to the post-COVID shift from globalisation to regionalisation, as countries take steps to secure their supply chains and protect their battered economies.

A recent megatrends investment forum hosted by Kim Catechis, investment strategist for the Franklin Templeton Investment Institute, turned its attention to the risk to the globalisation megatrend that has shaped global trade patterns for the past 50 years.

Alastair Reynolds, portfolio manager for Global Emerging Markets Strategies at Martin Currie and panellist at the event, noted: “Globalisation has proved a great boon for emerging market economies over much of the last 50 years, but looking forward, I expect that regional trade patterns will prove more influential than globalisation in determining the fortunes of emerging market companies.

“In the short term, this is likely to be most powerful amongst pan-Asian franchises, as I expect Asia to remain the most dynamic region on a global basis. It might also alter M&A preferences of companies away from seeking global expansion in favour of building regional dominance.

“So, near-neighbour acquisitions in Asia, Europe, Africa and the Americas may be a feature. Regionalisation could be motivated by serving regional preferences in financial services, infrastructure or consumer goods, or its motivations could be more political, such as in guaranteeing supplies of key commodities or inter-operability of technology and communications.

“A move from global ‘just-in-time’ supply chains towards more localised ‘just-in-case’ supply chains will necessitate a new wave of investment in fixed assets, which should be positive for capital goods companies, building materials and industrial real estate. There will also be a one-off step-up in demand as this new supply chain is stocked with inventory.

“However, the increase in activity required to create and stock a more localised supply chain will bring increased costs. Ultimately, someone must bear this cost, and this will present a new test to pricing power throughout industry supply chains.”

Sonal Desai, chief investment officer of Franklin Templeton Fixed Income and another panellist at the forum, added: “Rising protectionism, together with the pandemic, is driving changes in global supply chains and global trade. In the short term, these increase the risk of disruptions and related inflationary pressures.

“In the longer run, they will highlight the importance of well-developed local and regional supply chains, which could become a critical competitive advantage for countries and companies.”

The post The rise of regionalisation offers risks and rewards appeared first on AdviserVoice.

]]> https://www.adviservoice.com.au/2021/10/the-rise-of-regionalisation-offers-risks-and-rewards/feed/ 0