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Templeton Enlarges Bet Treasuries Are Doomed by Rising Rates

Updated on
  • Global bond fund cuts duration deeper into negative territory
  • Wager dominates Michael Hasenstab’s flagship portfolio

Michael Hasenstab has been waiting since at least 2016 for his wager on rising U.S. rates to come good. Now he’s adding to the position.

The Franklin Templeton bond chief, known for staking vast sums on conviction trades, has been loading up on wagers that protect against a spike in yields in his $38 billion flagship Global Bond Fund. The move has pushed average duration in the portfolio to the shortest on record.

Michael Hasenstab

Photographer: Christopher Goodney/Bloomberg

While Hasenstab is best-known for his huge one-way investments in emerging-market debt and currencies (he once bought half of Ukraine’s sovereign dollar debt), the bet against U.S. Treasuries has come to dominate his fund over the past two years. Even his core investments in developing nations reflect his conviction that rising interest rates are about to start wreaking havoc across markets.

“We’ve been focusing on specific emerging markets that have shown resiliencies to a number of external shocks, including rate shocks,” Hasenstab said in emailed answers to questions. “We’ve preferred countries with relatively higher yields that are better positioned to absorb rising rates.”

Mexico, Brazil, Indonesia and India, which all have bond yields above 6 percent, are the “types of emerging markets we’ve been emphasizing,” he said.

While it was a lonely trade at the beginning, this year is shaping up to be different. More have rushed to join Hasenstab betting on faster Federal Reserve rate hikes, with speculators amassing record short positions on Treasury futures. Ten-year Treasury yields touched 2.88 percent Thursday, once again brushing up against the highest level since 2014, partly in response to a soft 30-year auction.

After three years of outflows and lackluster returns, the Templeton fund has posted a 1.5 percent gain in 2018, beating 73 percent of peers, according to data compiled by Morningstar Inc.

Hasenstab said he’s using interest-rate swaps as one of the primary vehicles for his view. The fund’s average duration -- a measure of how sensitive bond prices are to rising rates -- fell to -0.38 years at the end of December, filings show, down from 0.41 years at the end of 2016. The Citigroup World Government Bond Index the fund uses as a benchmark has an average duration of 7.82 years.

Fellow luminaries Bill Gross and Jeffrey Gundlach have painted similarly stark scenarios for the bond market this year. But Hasenstab stands out for the scale of his pessimism and the way he’s acting on it. He’s also taken net-negative positions in the euro and yen, which he expects to weaken against the dollar as interest-rate differentials with Europe and Japan widen.

For a QuickTake on Fed unwind and market impact, click here

Hasenstab said in a blog post Thursday that recent market volatility hasn’t changed his core view on the U.S. economy. He said late last year that inflation could accelerate faster than expected as the economic recovery fuels a credit expansion. He also said that the market is overlooking the fact yields will have to rise to a level that makes them attractive to the banks and mutual funds that will have to take up the slack after the U.S. central bank trims its mammoth crisis-era debt holdings.

“As the Fed unwinds its balance sheet, we should ask not whether yields will rise, but how much faster and higher than market expectations,” Hasenstab wrote. “Only an extremely unlikely combination of events could ensure a smooth and painless transition.”

— With assistance by Srinivasan Sivabalan, and Edward Bolingbroke

(Updates Treasury move in sixth paragraph, adds Thursday blog post in 10th paragraph.)
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