Fiscal union is critical to the survival of the euro, says Michael Hasenstab (pictured), Portfolio Manager and Co-Director of the International Bond Department at Franklin Templeton Fixed Income Group…
Despite on-going market volatility, we have continued to position ourselves to seek to manage the interest-rate risks that we expect from the combination of historically low interest rates and easy monetary policy in the G-3 (i.e., the United States, the Eurozone and Japan), rising price pressures emanating from China and global demand that we believe is far from collapsing. Thus, we have generally been quite defensive with regard to interest-rate risk, while seeking to take advantage of what we deem as the relative attractiveness of currencies of countries with fundamentals likely to support medium-term growth.
Regarding Europe, a fiscal union is critical to the survival of the euro, in our view. We believe the debate over austerity versus growth is misplaced. We also think fiscal consolidation is an absolute requirement, as are growth-enhancing policies. Although we expect near-term growth in the monetary union to be anemic, that does not necessarily translate into the union’s demise. Importantly, growth in some parts of the Eurozone has not been as bad as the overall picture, with Germany, in particular, remaining a bright spot. Although we expect volatility due to news in Greece to persist, we believe the country is more likely to remain in the monetary union than not. Additionally, as long as the ECB continues to commit its firewall to the situation, we do not see any reason why the issues in Greece should domino throughout the rest of Europe. Panic surrounding issues in the rest of the Eurozone, such as in Spain, Italy and Ireland, also appears to us to be overstated.
In China, we expect a moderation of growth accompanied by a number of policy reforms that we believe could lead to sustainable levels of growth as the economy increasingly relies on rising consumption. China is such an important price setter for so many goods that we believe upward pressure on wages in China, driven by labour shortages, is likely to support domestic consumption as well as transmit higher prices globally. This outlook is one of the reasons why we generally have continued to be very defensive on interest-rate exposure.
As for emerging markets, we expect many of them could benefit from solid fundamentals as well as on-going capital inflows from worldwide quantitative easing. We remain very encouraged about the growth prospects and low indebtedness in many emerging markets. Outside China, the rest of Asia ex-Japan looks reasonably strong to us, as do select economies in Latin America, Scandinavia and eastern Europe. Near year-end, many countries in these regions also offered higher short-term interest rates and had undervalued currencies, in our opinion. We favour those countries with policymakers who have stayed ahead of the curve regarding fiscal, monetary and financial policy.