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By Jeremy Glaser | 05-13-2015 02:00 PM

Hasenstab: Flexibility Key in Global Bonds

The Templeton Global manager discusses recent Europe bond volatility, the outlook for the dollar and emerging markets, plus the need for a dynamic approach to international bonds.

Note: This video is part of Morningstar's May 2015 International Investing Week special report.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm speaking today with Franklin Templeton's Michael Hasenstab. We're going to look at some of the recent turmoil in the bond markets and also how he thinks investors should think about international bonds as part of their portfolio.

Michael, thanks for joining me today.

Michael Hasenstab: Yes, my pleasure.

Glaser: Let's first talk about the European bond market. It's been a tumultuous couple of weeks there. We've seen some pretty significant moves in a very short period of time. What do you think is driving that move in European sovereign debt?

Hasenstab: I think there are a couple of factors: One, it had become definitely the consensus trade, and everyone was getting a bit complacent, given where the actual levels were. But then, this month, in one of the rare exceptions, you had more issuance than they were actually buying back--although on net, the ECB will be taking out more from the market over the course of their program than governments will be issuing. So, the ECB, I think, still will have an important role there.

The other factor, though, that came out--and this is something we'd been looking for earlier this year--was that [quantitative easing's] effect on euro depreciation has a pretty meaningful impact on the growth of German exports, which has a very meaningful impact on European growth in a pretty short order. We're talking months, not quarters. And so you've seen growth come out a little bit better than I think people expected. You had a crowded market, a little bit better growth, and these types of moves get extreme.

Glaser: So, what's you outlook for Europe, then? Is this just a temporary move and we're going to see yields come back in again? Or is this more of a durable move?

Hasenstab: We have very minimal exposures. We have a little bit of exposure, for example, to Ireland, but nothing to places like France or Italy or Germany--the kind of core markets--because we just didn't see value there. And so, at this point, even despite this move, we're not being enticed to change our view. Ultimately, our view globally is for rates to go higher over the long term. Europe will probably take longer than the U.S. will; but nevertheless, we're not seeing a lot of value there.

Glaser: I want to dig a bit deeper into your comments about currency and how that's impacting growth there. Generally speaking, even though the dollar rally has slowed a bit, what impact is the stronger dollar having on global bond markets. What impacts will that have?

Hasenstab: I think there are a couple of separate factors happening. I think what's happening in the currency market is quite interesting. We would expect that--despite this pickup in European growth and despite the temporary slowdown in U.S. growth on the back of decreased oil production--over the course of 2015, U.S. growth will outperform European growth. U.S. monetary policy will move to more of a tightening bias than European policy. Similarly, for Japan, we expect their policy to remain a lot looser than the U.S. and growth in the U.S. to outperform. Under that environment, the dollar should appreciate against the euro and should appreciate against the yen.

That being said, it's not going to be uniform against the rest of the world; in fact, places like Mexico have already priced in basically a significant Fed tightening. The market has, in our view, got massively oversold. Mexico's peso is trading at some of the weakest levels on record. We think there's a lot of upside room in places in select emerging markets to actually appreciate against the dollar, even though the dollar will be appreciating against some of the other majors.

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