The Federal Reserve is falling further behind the curve by not raising rates and could be creating a ‘toxic mix’ of inflationary dynamics, according to Michael Hasenstab.
Hasenstab, who is CIO of Templeton Global Macro, made the comments in the wake of the Federal Reserve opting to hold rates steady at its September meeting.
Across his global and emerging market funds, Hasenstab has sought to remove interest rate risk, particularly when it comes to US treasuries. ‘We do not want to bet that foreign investors will want to continue funding US deficits,’ he said.
‘It is our belief that the United States is likely to see expansionary fiscal policy next year, and if you combine that with expansionary monetary policy - assuming the Fed remains on hold - it could be a toxic mix in terms of inflation dynamics.
‘We think investors are taking on significant risks in betting that this multi-decade treasury rally can repeat itself,’ Hasenstab added.
Hasenstab said the Fed is falling behind in its efforts to normalize its rates environment, as it is not capitalizing on the fact employment is near capacity.
‘A number of observers have stated that sluggish US - and global - economic growth is good reason for the Fed not to raise rates, but we would argue that monetary policy alone cannot engineer growth, nor is it the Fed’s role.
‘Instead, the Fed should be focused on its dual mandate of maximizing employment and maintaining price stability. If the United States is actually experiencing a “new normal” where growth remains lower long term, then the Fed risks fueling real or asset-price inflation by being too lax with monetary policy going forward.’
Hasenstab said the Fed is continually ‘finding excuses’ not to raise rates while overlooking the fact it benefits from global liquidity that pushing down rates creates.
‘Financial repression is driving some investors to buy US treasuries, which creates an artificial bid. However, if we see headline inflation rise to 3%, along with full employment and the economy growing at its full potential, we think many investors are going to question why they are buying a US 10-year bond at 1.6%-1.7%, which is offering a negative real yield.’
The Templeton Global Bond fund lost 2.5% in US dollar terms over the three years to the end of August 2016. This compares to an 8.6% rise by its Citywire-assigned benchmark, the JP Morgan Global GBI Unhedged TR, over the same time frame.