Aftershocks of a Post-Pandemic World: Global Macro View

Aftershocks of a Post-Pandemic World: Global Macro View

March 9, 2021

Michael Hasenstab

Host: Hello and welcome to Talking Markets: exclusive and unique insights from Franklin Templeton.

Ahead on this episode: why some investment focuses are turning to Asia…plus, dissecting the inflation debate from both sides.

Michael Hasenstab, Chief Investment Officer, Templeton Global Macro, shares his views with Franklin Templeton’s Katie Klingensmith.


Katie Klingensmith: Thank you Michael for joining us today. Let’s start out with, really, just how much the world has changed since last fall. I think many of us are feeling more hopeful now with a vaccine being developed so quickly and being distributed. What are you seeing in this changing environment and how does it impact your investment strategy?

Michael Hasenstab: Yeah, you know, certainly I think if we go back four or five months, the idea of a 95% efficacy vaccine that was produced across the globe by multiple companies was really a hope, but no one really believed it would happen. And then in the beginning of November, that was realized, and that I think is a game changer. And I think that goes to the hope you were talking about as we look into the spring and summer, I think it's a much, much different world. We saw human behavior over the last, you know, couple months—people just needed to get out, even though there was a risk of getting sick. If you take that human behavior of a need to get out and re-engage the world, we're social beings and people just need to work—they want to work.

That, with a vaccine, I think we're going to see a pretty big spurt of economic activity from the spring through the summer, and then continuing on. And that, I think, is a game changer.

The other change factor was international approach to diplomacy. And the previous US administration—and I'm not judging, right or wrong—just made a very high-risk approach to international diplomacy. It was very confrontational, somewhat unpredictable. This new administration has put in diplomats across the various agencies. And, I think we're going to see something more similar to what we saw under George Bush Senior, George Bush Junior, Bill Clinton, parts of Obama, something that is more predictable and more orthodox.

Why is that important? Well, one of the areas we’ve been so interested in for a while, but really couldn't execute given the pandemic or the geopolitics, is in Asia. And the US and China are really now competing superpowers of various, you know, degrees of strength. But there's no question China is wanting to rise into that role. That is creating incredible frictions.

This new administration is no more pro-China or anti-China, I think, than the previous administration. In fact, I think there's a real anti-China sentiment going across the political aisle in the US, and in China, there's a pretty strong anti-US sentiment that is felt by a lot of people. So, that confrontation is not going away and that's going to be something, that's going to be a challenge for both of these countries to deal with over the next five to 10 years.

However, the chance that it goes to the tail extreme and, really just escalates out of control, I think, is reduced because of the orthodox approach to diplomacy. And I think that is the second big change variable. So, both of these then unleash some of the opportunity in Asia.

Katie Klingensmith: So you see a lot of opportunity in Asia. Take us through the factors that are driving that optimism about Asia, especially how you view them going forward, post-pandemic?

Michael Hasenstab: You know, you could find as attractive an opportunity in Korea, but if you're in a global recession, they're a big exporter and require capital into their financial markets. That just, it doesn't work with a global pandemic and the risk of a tail event between the US and China puts it in a danger zone.

Take those two away, and all of a sudden, now we can look at, you know, what are the fundamentals in Asia? And I think from an investment standpoint, very attractive. They run large current account surpluses, so their trade surpluses of bringing in capital – that generally helps appreciate the currencies. They have relatively stronger growth rates. Certainly, the US is going to bounce back this year in a meaningful way. But China last year grew over 2% and this year will probably grow well in excess of 8%. India will likely be in double digit growth rates this year. So the growth advantage, I think, is centered around Asia. The interest rate advantage, it varies across countries, but generally rates are higher in Asia, whether it's Indonesia and India close to 6% or China close to 3%, you do have some interest rate advantage. Fiscal accounts, generally, not every country, have an advantage. They didn't have the huge debt, and they're not continuing to accumulate the debt like we're seeing here in the US. I mean, the US had 100% debt-to-GDP last year. We're going to be close to a 109-110% debt-to-GDP this year. Those are big, big numbers.

The other factor that's appealing in Asia is their ability to handle a pandemic. Now, we're pretty hopeful that these range of vaccines are going to deal with the current strain and other strains that keep morphing, but we don't know. What we do know, over the last nine months, if we do go back to a difficult pandemic, at least Asia has that capacity to better deal with that.

And lastly, Asia's within the Chinese currency orbit, and I think the Chinese yuan is a different dynamic today than it's been really for the past 50 years. This is moving to become a global currency, an international reserve currency. There is a desire in China to expand their role globally, and part of that is the role that their currency will play. And, if you have a gradual and steadily increasing currency or appreciating currency, that captures the orbit of the rest of Asia. So those dynamics in Asia now, unleashed by the vaccine and unleashed by lower temperature diplomacy, I think makes 2021 an exciting opportunity, particularly for investors who are based in some non-Asian currencies.

Katie Klingensmith: What about monetary and fiscal policy? How does it fit into the equation, in particular in the US?

Michael Hasenstab: I think a lot of the challenges today in the US are rooted in big income inequality issues. The pandemic made those even worse. There's a need to solve for those, without question. The solutions, long-term, are probably a 20-year plan on education and other macroeconomic policies, but in the very short term, policy makers have taken the approach of just large transfers, which is very expensive.

So the fiscal accounts, I think, even getting out of this pandemic, there is going to be an ongoing desire, given the political makeup of DC, to increase those transfers and that's expensive. At the same time, there's a desire by policy makers and the monetary regime to keep rates very accommodative. Central bank mandates were changed to allow average 2% inflation, as opposed to that being a target, which means there's a comfort going over that number. And that doesn't mandate, then, if we get a 3% inflation number, that the central bank actually has to raise rates. They can keep them very accommodative. And I think every messaging we've seen and every action we've seen indicates very accommodative monetary policy. So, if you have very accommodative monetary policy and very accommodative fiscal policy, something has to give. Some people would think inflation would be an element that gives, but even if that doesn't give, the value of our currency is likely to be on decline. And you combine that with what I talked about in Asia, that, to us, is really a compelling channel for 2021.

So we've got the problems in the US with our debt and with our low rates. Juxtapose that against Asia, and I think a currency realignment is something that we're quite excited about. The other factor that all of this does is changes the landscape for emerging markets. If you have global growth stabilizing, if you have commodity prices stabilizing or rising, all of a sudden, you know, emerging market country fundamentals matter more, and you can pick those opportunities.

Katie Klingensmith: Alright, let’s talk more about inflation. There's been a big focus on inflation with the back-up in rates and a lot of volatility in the last few months. Do you think we're at the cusp of a period of more sustained inflation in the US and globally?

Michael Hasenstab: This is the number one topic, I'm sure everyone's debating. It's certainly the number one topic we're debating. One of the strengths of the team we've built is to have diversity of perspective. I think there's some very strong arguments for why inflation can pick up with this, you know, massive growth spurt. It’s been very sharp. At the same time, we've had some supply disruption, so there's a bit of a mismatch there. I think this money that we've pumped, not just into the banks this time like we did in GFC [Global Financial Crisis], but we've pumped it into people's individual accounts. There's an ability for that to spend and create the velocity of money going higher. I think, you know, it would be a surprise to me if we didn't get some sort of inflation. However, we have some very smart people on the team who I trust a lot and listen to them and will have different views in this and we've had big debates. And they’ve come up with some very strong arguments. Looking back throughout history, you cannot get inflation, at least historically, if you have a negative output gap. And yeah, we're going to grow this year. There's a nice spurt, but we still have huge excess capacity and a lot of capital and a lot of labor. And until we grow faster than the potential of our economy, it's hard to get inflation. So, you could have that dynamic for a number of years before you see inflation kick in. I think that's a strong argument.

The other argument is on wages. You look back throughout history, you don't get inflation without wage inflation. How are we going to get wage inflation if we have still very high unemployment? We have all of these automation factors that we're all aware of that suppress labor prices. I think that's an important point.

And then, the last point would be persistence. You can't get inflation just from one-off shocks. It needs to be indexation of wages, for example, or indexation dynamics that are persistent over time, not just a six-month dynamic.

One of the most important drivers of inflation over the years has been people's expectations. So the question is, do we get this rise in temporary inflation, which I think we all agree has to happen. Does that change people's expectations, which feeds back into wages and feeds into pricing behavior? That’s the real question. So, watching inflation expectations, I think, is the driver, but it is a healthy debate. And again, as I said, I think the strength that we have as a team is that we don't all think the same thing. But what we did all agree on was that this dynamic is really bad for the value of the dollar. So, while we're split on inflation, I think there's a lot of consensus that the value of the dollar has peaked and will probably decline.

Katie Klingensmith: Related to your outlook on the dollar, you mentioned earlier concerns of high fiscal deficits on top of some already high debt burdens. This isn’t just a US issue.

Michael Hasenstab: So yeah, putting the fiscal into context, advanced economies globally are running debt-to-GDP ratios that are as high as they were at the end of World War II reconstruction. So, we rebuilt the entire world and that's where the debt got too. We have the same debt levels, and we haven't built anything. So, I think that starting point is problematic and cannot be ignored, certainly for the developed world. And I think that is going to play through, either it leads to higher yields, but if your monetary policy is to suppress those yields, that escape valve doesn't happen and that's why it has to go vis-a-vis the currency.

The good news is you know, emerging markets in many cases, some are excluded, don't have that exorbitant privilege. They can't get away with bad fiscal policy because the rates do go significantly higher, and the currency gets hit right away. So, places like Indonesia have run very prudent fiscal policies, which gave them the ability to spend during the crisis and then revert back to that more conservative approach now that we're out of the crisis. And so, I think as we look around the global landscape, there are definitely places that don't have this indebtedness problem that is centered in the US, and Europe has pretty high levels of debt as well.

Katie Klingensmith: And I know that's connected also to your understanding of what could be a rising Chinese currency or more importantly, the rising potential that the Chinese currency serves as a reserve currency. You touched on it earlier, but take us through your thoughts of the yuan and just overall in China, where you see risks and opportunities.

Michael Hasenstab: China is important to decompose some of the factors that were already there for the last decade and some of the new factors. The factors that were already there—China was becoming a big global economy, it mattered in the world. They were opening their capital accounts. They were increasing trade financing in yuan. All of those things were taking them on a general trajectory to become a rival—probably not surpass the US anytime in the near term, but to rival and have that trajectory of a reserve currency. What has really changed, though, more recently, has been the digitalization of the Chinese currency. I think we're all aware of the fascination with cryptocurrencies, but the idea of digitizing a currency is going to happen. It's just a digital mechanism of replacing a quasi-physical piece of paper. China is far ahead of that sort of development. In fact, they've been launching test cases in China to start to have more formal digitization backed by the PBOC [People's Bank of China]. So, it's not backed by some private sector or unknown algorithm. It's just backed by the government. So that is a different dynamic.

If you have digitization, which I think can be exponential like we’ve seen in technology and many sectors, then all of a sudden you have more assets that very quickly are owned and denominated in yuan. And that accelerates even beyond them opening their bond market to the foreign investors. So digitization, I think is important.

The other difference is that this is happening at a time when the US is pursuing what could be called MMT [Modern Monetary Theory], and that is not good for your currency. So, you have some problematic fiscal monetary policy in the US, and some in Europe. At the same time, you have this going on in Asia.

And lastly, I would say, you know, China has a different global appetite today than it has had for probably 2,000 years. There's a lot more outward expansion—One Belt, One Road—and all of those outward expansion dynamics seem to signal that desire to have a bigger stage in the global platform. And with that, I think comes the role of a currency to be more of a stable reserve currency. I think that's the objective.

Now, there are lots of challenges, certainly, in China, and I think there's lots of questions, probably more in the US and in Europe, over does this model work? But, I would also want to recognize that in large parts of Asia, and some parts of Latin American and Africa, there is a more of a comfort that the Chinese model is something they would prefer to follow or at least be more engaged with. And so, you know, while we sometimes have the cultural biases if we’re sitting here in the US or Europe to say, “This is very different, and therefore we won't adopt it.” Our exposure and understanding and talking to people in other parts of the world is that's not always the case. So, I think a lot of things are lining up that we probably will see the yuan grow in terms of an international currency faster than probably we would have anticipated in a traditional model five years ago.

Katie Klingensmith: Michael Hasenstab, Chief Investment Officer, Templeton Global Macro, thank you for taking the time with us.

Host: And thank you for listening to this episode of Talking Markets with Franklin Templeton. If you’d like to hear more, visit our archive of previous episodes and subscribe on iTunes, Google Play, Spotify, or just about any other major podcast provider. And we hope you’ll join us next time, when we uncover more insights from our on the ground investment professionals.

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