Franklin’s Desai Sticks to 3% Yield Call That’s Elusive as Ever

(Bloomberg) -- It’s been a tough year for investors predicting higher Treasury yields, with the 10-year rate tumbling 100 basis points and the world’s biggest bond market on track for its best annual performance since 2011.

The consensus on Wall Street is for 10-year yields to remain below 2% until mid-2021, as expectations for global growth sag and traders brace for a likely third straight Federal Reserve rate cut next week.

But Sonal Desai, chief investment officer of Franklin Templeton’s fixed-income group, is sticking by her forecast for the yield to surge to 3%, a level not seen since December, and up from about 1.75% at present.

She now sees that 3% mark in 12 months, rather than her prior call for the end of 2019. She reiterated that year-end view in July, just before the rate started its dive to a three-year low amid escalating trade friction. For Desai, the case for higher yields comes down to ballooning deficits, the prospect of stimulative fiscal and monetary policy, and her view that inflation is set to rise on job-market strength and accelerating wage growth.

“At the start of this year, I misread how much the Fed would be swayed by the markets, and that makes it much harder to call,” Desai, who oversees $155 billion from San Mateo, California, said in an interview. When asked about her 3% yield forecast, she said: “Do I think 3% is out of bounds for 12 months from now? Absolutely not, I think it could happen based on what I see.”

She’s hardly alone in her bearish target for Treasuries, which looks even more elusive than when she voiced it back in April. A bet against Treasuries by her colleague Michael Hasenstab went wrong in a big way in the third quarter. And back in September, after a ferocious bond rally drove yields in the world’s biggest markets to record lows, some investors were saying that’s as low as they’d go.

For Desai, the looming 2020 U.S. election plays into her outlook.

Both major political parties have “embraced very loose fiscal-policy agendas, so regardless of the outcome of next year’s election, I expect fiscal deficits to widen, boosting Treasury supply and outstripping demand,” she said. “This will cause prices to fall as we move further down this path of incredibly easy fiscal policy, hand in hand with very easy monetary conditions.”

Fed Call

When the year started, Desai had expected Fed rate increases in 2019. At the time, many were betting the central bank wouldn’t raise rates at all this year, and traders were upping wagers on a 2020 cut. The Fed then lowered rates in July and September amid weak global growth, uncertainty about the trade war and subdued inflation.

In February, she predicted an even higher yield level, saying the 10-year might reach 3.5% to 4% in the medium term.

She’s been less pessimistic on the U.S. and global outlook than some prognosticators. She sees global growth moderating and the U.S. poised to expand by 2% to 2.25% this year, with no signs of imminent recession.

Before assuming her current post in December, the Indian-born Desai worked as a portfolio manager with Hasenstab. She now oversees a different set of funds, including the $4.7 billion Franklin Total Return Fund. Its 2019 return of 8.4% puts it in the middle of its peers, according to data compiled by Bloomberg.

Another fund, the Franklin Strategic Income Fund, has gained 7.9% this year, besting about 70% of its peers, Bloomberg data show. She says it’s gotten increasingly difficult to find opportunities in credit markets, but that she’s finding some in higher-rated collateralized loan obligations.

Years of easy monetary policy and low rates have forced investors into ever-riskier assets, and financial stability is an issue that’s “front and center” in her mind, she said.

She expects the Fed to lower rates next week. But she doesn’t expect an extended easing cycle and says it would be “wise for policy makers to start guiding markets away from anticipating continual cuts at every meeting.”

With the U.S. jobless rate at a 50-year low, she says she’s “heartened” to see some Fed officials recognize the financial-stability risk that comes from low rates.

“The Fed essentially exchanged volatility at one point for unknown volatility at another, and has not responded to the underlying economy,” she said. “Markets have been going along for the ride, and I definitely don’t see yields being permanently lower.”

--With assistance from Natasha Doff.

To contact the reporter on this story: Vivien Lou Chen in San Francisco at vchen1@bloomberg.net

To contact the editors responsible for this story: Benjamin Purvis at bpurvis@bloomberg.net, Mark Tannenbaum, Greg Chang

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