Allocation Views

Hold the course.

Franklin Templeton Multi-Asset Solutions


As the world adjusts to life with the specter of COVID-19, it is increasingly clear that much has changed. We have become used to social distancing and unimaginably weak economic data. However, although we have become familiar with these new features of our lives, we hope that they will not be with us for too long!

One thing has not changed, and perhaps it is a fundamental feature of financial markets: government bond investors typically see the glass as half empty, whereas equity markets are the more optimistic half of this comparison. Part of the conundrum relates to investment horizon. Stockholders typically buy into optimism, with the promise of longer-term growth or the realization of underappreciated value. Meanwhile, bond investors worry about not making it quite that far, and are more concerned about whether they will be paid their next coupon.

When we listen to central bankers such as US Federal Reserve (Fed) Chairman Jerome Powell, they are aligned in their message of doing “whatever it takes.” As we discussed last month in Allocation Views, calls for the coordination of monetary and fiscal policy have become a new normal. But we also hear something like the “pragmatism” of a bond investor speaking to us. Despite the Fed cutting interest rates to effectively the zero bound and providing an array of lending programs to underpin liquidity across financial markets, Powell worries that it might not be enough. Interest-rate futures markets also share some of this concern and have moved to discount the possibility of rates falling below zero in the United States, even though the Fed strenuously resists this notion.

Powell also worries about the lasting effects a recession could have on business investment and the impact on productivity growth and incomes. This is why the Fed is emphasizing the need for fiscal stimulus while continuing to buy US Treasury and mortgage-backed securities in whatever amounts are needed to support market functioning. It promises to do so until the United States is well on track to attaining the Fed’s inflation and employment goals. Powell’s peers at all the major central banks share such uncertainties over the outlook.

The outlook in Europe is at least as uncertain as it is in the United States, and European Central Bank (ECB) President Christine Lagarde seems similarly concerned. The ECB has introduced new refinancing and liquidity operations, but like the Fed, it is not in the business of handing out public money; that is the preserve of elected governments and hopefully in the medium term, a collective European Union (EU) effort. Lagarde’s difficulties were compounded by the recent German Constitutional Court ruling against the European Court of Justice’s support for the ECB’s asset purchase program. We do not believe that this will result in a premature end to this program, but it does present an obstacle and shows the EU in a poor light. Despite this, Lagarde seems intent on leaving the markets under no illusion that the central bank will hold the course.

The global economy is already in a severe recession, and it is unclear how smoothly the phased release of lockdowns will be. A second wave of infection might lead to renewed restrictions and a slower recovery. Reflecting the balance of issues noted above, we are focused on the potential for the risks in the near term to remain skewed to the downside.

As a result, this leaves us with a relatively cautious view, encapsulated in “Significant Headwinds to Global Growth.”

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