Hasenstab's Huge Bet Against Treasuries Is Getting Wiped Out

(Bloomberg Businessweek) -- Few prominent investors have been punished harder for being on the wrong side of plummeting bond yields than Franklin Templeton’s Michael Hasenstab, who manages funds with total assets of about $115 billion, including the Templeton Global Bond Fund.

The flip side of falling yields and interest rates has been a rally in the bond markets. As yields drop, bond prices rise, and in recent months, owning U.S. Treasuries have been an easy way to make money. So it’s been a tough time to hold the view that the long era of low rates—which began with the financial crisis over a decade ago—is about to reverse.

Hasenstab’s not only less bullish than most bond managers—he’s actively shorting Treasuries, making bets that rates will rise and bond prices will fall. This puts him at the epicenter of a debate that’s split global markets.

If he’s right, the world economy is turning a corner, central banks will finally be able to raise interest rates back to their pre-crisis levels, and global bond yields will stop grinding ever lower. If he’s wrong, it may be because the global economy is too weak for central banks to stop trying to pump it up. So far, the scoreboard doesn’t look good, either for the economy or Hasenstab: after increasing rates for the first time in almost a decade in 2015, the U.S. Federal Reserve is back to cutting, and the Templeton Global Bond fund has lost 4.8% in the past month. The damage was partly offset by holdings in emerging-market currencies, until some of those— most notably Argentina—also started to sour this month.

Hasenstab’s position started out small but has been growing steadily over the past two years, quietly becoming the biggest bet against Treasuries of any major global bond fund. He shorts Treasuries by buying interest-rate swaps, a contract investors use to speculate on the level of interest rates in years ahead.

Hasenstab’s unwavering argument has been that economic strength in the U.S. will make today’s low-yielding bonds less attractive, especially if consumer prices start to rise. The short position “hedges the risk that rising inflation, a high reliance on foreign investors to fund increasing budget deficits, and highly stimulative monetary policy at a time of solid growth and record employment, could push longer term interest rates higher even while shorter term rates remain low and anchored,” he wrote in an email.

The economics that Hasenstab studied to earn his Ph.D. might suggest that’s a pretty straightforward view to take, but textbook economics isn’t necessarily the best way to navigate the current market. Take the past month, when the Federal Reserve cut the key rate, despite still-solid growth in the U.S. economy. And then there is the curious phenomenon of negative interest rates in Europe and Japan, where investors are willing to sacrifice a small portion of the money to keep it safe. That’s also tended to pull U.S. bond yields lower; when it actually costs money to lend to the German government, many global investors are happy to be paid even the yield of less than 1.6% that 10-year Treasuries offer.

Other prominent investors, such as Guggenheim Partners’ Scott Minerd, have also questioned the economic logic of Fed rate cuts at a time of economic strength. “By almost every measure policy makers should be considering another rate hike in anticipation of potential economic overheating,” he wrote in a commentary on the $270 billion asset manager’s website last month. On Aug. 13, however, Minerd told Bloomberg Television that the Fed should cut rates again to calm recently anxious markets and “send a clear signal” that it won’t allow a recession.

Trying to predict where rates are headed in the current environment is a “fool’s game,” according to Gershon Distenfeld, co-head of fixed income at AllianceBernstein in New York. Even if it becomes clear that rates are going to rise, yields won't necessarily go up in a straight line, he argues. “Who the heck knows what will happen with bond yields?” Distenfeld asks. “No one thought yields would go this low. Six months ago, we were talking about how much they were going to go up.”

Hasenstab is no stranger to taking risks, though, and some of his past wagers on government bonds in such countries as Ireland and Hungary have delivered spectacular returns. And when bond yields have shot up in recent years, such as in the aftermath of the U.S. 2016 presidential election, the fund has handily outperformed its peers.

“It's a very aggressive, high-return strategy that investors need to be patient with,'” says Karin Anderson, director of manager research at Morningstar Inc., which gives its top analyst rating of gold to Templeton Global Bond Fund. “They have really dug into this position, and I don't know that they're going to walk away from it anytime soon, because they don't agree with the Fed's approach of being so concerned about external factors, rather than actual U.S. growth.” Still, Anderson says, if the Treasury short continues to grow, and Treasuries continue to rally, Morningstar might consider putting the fund under review. —With Cecile Gutscher

To contact the editor responsible for this story: Pat Regnier at pregnier3@bloomberg.net

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