Head of European Fixed Income at Franklin Templeton: “We are going to see a double dip in growth in Europe”

English2020. nov. 30.Harsányi Péter

Hungary and the greater CEE will experience a slowdown, but that will present opportunities for active investors – the Head of European Fixed Income and Senior Vice President of Franklin Templeton told növekedés.hu. According to David Zahn, the approval of the European Rescue plan is excellent news for the European economy. It is also quite positive for government bonds, corporate bonds, and probably other European currencies in addition to the euro. He added, the continent is not as risky to invest in now as it might have been before. Therefore, the risk premium should decline.

How do you assess the economic prospects of the eurozone, the CEE region and Hungary?

The economic prospect is not very good. Europe is pretty much locking down across all countries to various degrees. Some is regional, some it is the whole country. So, I think we are going to see a double dip in growth in Europe. We had started to recover in the third quarter. We are going to go back down and have slower growth.

And so that means there will have to be more monetary and fiscal stimulus to respond to that.

So far, The COVID-19 crisis has had a deflationary effect, and we think even with some recovery, inflation should remain quite low within Europe this year and probably into next year.

Some observers are concerned that in a world awash with liquidity from all this fiscal and monetary support, we will see an inflationary spike down the road. Certainly, that is a potential concern, but we see that as several years down the road. That concern is a reason for investors to consider some defensive assets within overall portfolio construction.

Hungary and the greater CEE will also experience this slowdown, but we feel that will present opportunities for active investors. 

What are the relevant criteria for buying government securities in a given country? What factors are taken into account by Franklin Templeton?

We develop a portfolio that reflects the most attractive investment opportunities across the European Fixed Income market. To identify the best opportunities and generate consistent alpha we integrate our top-down macroeconomic views with bottom up fundamental research. This provides us with a competitive edge to navigate challenging investment environments and better serve our clients.

When we analyse economies in Europe our country, duration, and yield curve strategy is determined by combining in-depth country analysis that focuses on factors affecting a country’s fundamentals, such as monetary and fiscal policy, macroeconomic disequilibria and the capacity for change, and policy implementation, with robust econometric currency and interest rate modelling.

Once we decided to invest in a country, we decide how an allocation can fit into the strategy’s specific risk budget. This can shift due to the relative attractiveness of each security during global economic and credit cycles.

In which emerging countries do you have the largest bond investments?

The Franklin Templeton European Total Return Fund is a Pan European Fund that can invest in Emerging Market Countries in Europe.

We mainly invest in investment grade rated EM countries which are EU members.

We would not classify Poland and Hungary as EM countries and we would not invest in Turkey in our Fund. EM countries we hold in the fund with an average allocation of around 0.6% are Albania, Macedonia, and Tunisia to add some yield to the overall portfolio.

In the light of the epidemic, how risky are emerging markets and the CEE region? How do you see the riskiness and external vulnerability of Hungary?

We continue to hold Euro Denominated Hungarian sovereign bonds as we like the credit but do not think the domestic yields compensate for the additional risk.

What are the biggest risks to the markets right now?

In our opinion, the outlook for the eurozone remains difficult. The bloc is beset with a new wave of COVID-19 infections, negative interest rates and disinflation.

Although third-quarter GDP figures showed a strong recovery, the prognosis is bleaker amid increasing predictions of a contraction in the fourth quarter.

The eurozone will naturally be affected by the outcome of the US election, but the Biden victory is likely to be of benefit to the region. However, other political problems remain, notably Brexit, which continues to cast its shadow over Europe. Amid the Brexit stalemate, the UK also faces the renewed threat of a bid for Scottish independence.

Do you think the low interest rate environment can stay with us for a very long time?

The European Central Bank made it clear in their statement that accommodative monetary policy will remain for the foreseeable future to support the economy in Europe and we expect further easing to be announced at their December meeting.

We do not anticipate the European Central Bank lowering interest rates as they are already at very accommodative levels and reducing further negative will probably not have a significant impact.

We would expect the ECB focus will be on further quantitative easing combined with further TLTROs with accommodative terms to support the economy.

The approval of the European Rescue plan is excellent news for the European economy, and it also is good news for European fixed income markets, because it will likely bring down the risk premium (the amount of additional return required for the political risk of Europe, which has been reduced) across Europe.

From an investment standpoint, the news looks quite positive for government bonds, corporate bonds, and probably other European currencies in addition to the euro.

The COVID-19 pandemic has ravaged the economy, and the rescue plan sends a message that Europe is not as risky to invest in now as it might have been before.

Therefore, the risk premium should decline, particularly when combined with the ECB’s monetary policy support in the form of quantitative easing and ultra-low/negative interest rates, which look likely to continue for a long time.

In our view, this combined response to the COVID-19 pandemic is going to be really powerful in terms of helping the European economy start to recover.

That said, these supportive actions do not necessarily mean the European economy is going to recover quickly. It will probably take several years for a full recovery to get back to pre-COVID-19 levels, but it does mean the building blocks are now in place from the fiscal and the monetary side.

As a result of monetary policy responses to the coronavirus, the balance sheet of major central banks has increased significantly. Do you believe that central banks will be able to reduce their balance sheets in the long run or they will follow the Japanese way?

The ECB will continue to be accommodative for several years and I do not see them looking to reduce their balance sheet before hiking interest rates, as they have said, which we still see as 3-5 years out.

In your opinion, do the emerging countries of the European Union have sufficient room for more fiscal stimulus measures?

In our view, European bond markets should now be very well supported, and yields will likely be capped because if countries can borrow from the EU at a low interest rate, it means that they will not have to issue as much of their own debt. This is also quite positive from an investor point of view, particularly when looking at the peripheral markets.

Fiscal support has played a crucial role in supporting labour markets and firms since the outbreak of the pandemic and further easing is likely needed in the quarters to come as Euro area governments reintroduced restrictions during a second lockdown. Some European economies already announced more fiscal support in particular under the form of extensions to the furlough schemes. As the double dip in growth will be more evident, further fiscal measures also at the communitarian level cannot be excluded.

The Recovery Fund on a European level was a huge achievement, setting a historical precedent for the first large counter-cyclical and redistributive fiscal capacity aimed at supporting and transforming the European economies in the next years.

In our view the European Recovery Fund will be supportive for emerging countries of the European Union to help to repair the economic damage caused by the coronavirus pandemic.

Although some implementation risks linger on the program’s efficacy, the SURE program is currently running and addressing the crucial economic side effects of lockdowns. By receiving grants or by borrowing from the EU member states do not have to issue as much of their own debt which means that yields most likely will be capped, which will be supportive for European Bond markets and emerging markets in Europe.

Franklin Templeton is committed to integrating ESG factors into all asset classes and investment strategies. In your experience, what is the interest of clients in ESG funds? How do the assets managed by the Franklin Green Target Income 2024 Fund develop?

Yes, we at Franklin Templeton think that ESG analysis is not just about identifying and measuring risk, it is also about identifying investment opportunities. We consider ESG factors alongside traditional financial measurements to provide a comprehensive view of an investment and help identify those investments that have the potential to deliver sustainable returns.

When it comes to ESG in the fixed income world we have noticed that, for many investors, achieving attractive yield is not the sole consideration. A growing number of investors are focusing on the environmental, social and governance (ESG) characteristics of the assets they hold. And the good message is that income investors need not have to choose between their ESG convictions and their appetite for yield.

With the Franklin Green Target Income 2024 Fund we give clients the opportunity to support and invest in companies that are trying to progress on CO2 emissions and water usage. These are two areas people care much about and which are the easiest to measure from a fund management perspective.

This fund employs an engagement strategy to help drive additional improvements, as we believe that dialogue and partnership can help these businesses move further forward than they would be able to on their own.

We are very pleased with the client interest in this fund. Clients in Europe entrusted us with €418 million after reopening this fund for a second asset gathering period this year. Fixed maturity investments can be a great solution for investors that seek a regular income by investing over a fixed investment horizon usually over 5 years.

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