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29 March 2024

Global Fixed Income Investing

Michael Hasenstab

Published
By Michael Hasenstab

The International Monetary Fund’s October 2010 Economic Outlook described a heterogeneous pace of recovery across advanced and emerging economies. We have been positioning for this environment for some time and continue to see attractive opportunities presented by it. With emerging markets growing more rapidly than developed markets, we prefer defensive duration positioning; see the currencies of rapidly recovering economies as attractive, and still see select credit opportunities—particularly in emerging markets.

On the interest-rate side, we are not finding much value in the U.S., UK, Euro zone or Japan as the yields of U.S. Treasuries, German Bunds, British gilts and Japanese government bonds remain at historically low levels. We are worried about the ballooning U.S. fiscal deficits, and while interest rates are likely to stay low over the short term, the large deficits, quantitative easing and ongoing moderate economic recovery in the U.S. may put pressure on yields over the medium term. We see better value in other global markets with higher yields and less fiscal risk.

What we have been finding attractive are short-duration assets outside of the U.S. that offer yields in the 3 percent to 5 percent range without reflecting much duration or credit risk. In contrast, to get even a 2.5 percent yield in the U.S., we would have to go far out the yield curve. The opportunities outside the U.S. are the result of robust growth environments that have led many central banks to counter inflation pressures by tightening monetary policy. In these economies that do not face the same deleveraging challenges as developed economies, tightening policy has taken the form of interest-rate increases, less fiscal spending, and currency appreciation, all of which have supported our positions. For example, we were positioned in short-duration bonds in Malaysia, Poland and South Korea as of September-end. In addition to attractive yields, these positions could potentially benefit from the currency appreciation we expect in these economies.

Similarly, we also see opportunities outside of emerging markets, such as in Australia, Norway and Sweden. Australia has a public-debt burden of less than 20 percent of gross domestic product and has strong ties with China. In Europe, we favor Norway and Sweden, both of which have run very good fiscal accounts for a long time. Norway’s oil fund could pay down its entire bond market four times over.

On the currency side, we are looking for countries with stronger growth rates that are likely to lead to higher interest rates. Higher returns have been attracting record levels of capital, which has been fueled by very loose monetary policy in the developed world. These inflows have lowered the cost of capital in these economies, strengthening their domestically led recoveries. While there are concerns among policymakers about the risks of overheating and asset price bubbles, we have been encouraged by the prudent steps taken by policymakers thus far and do not see evidence of a bubble at this time as valuations have been supported by underlying fundamentals.

Michael Hasenstab, Ph.D., Co-Director/Portfolio, Manager, Franklin Templeton Fixed Income Group