Michael Hasenstab, Ph.D.
Co-Director/Portfolio Manager
Franklin Templeton Fixed Income Group

We believe there is going to be a fair amount of differentiation in terms of how fast countries recover from the current economic downturn. The varying speeds of recovery may have significant interest-rate and currency implications and may present some very interesting investment opportunities over the next couple of years. In particular, we believe there may be more opportunities in emerging economies than in some of the core developed economies.

There are several factors that may help explain a country's recovery path over the next few years. These include the size of its domestic economy and its export sensitivity. Another factor is the policy response adopted to deal with the global recession. Future capital flow dynamics also come into play, and they may be affected by relative growth rates. There also is the overhang from previous excesses-in terms of leverage and over-consumption-and the resulting amount of debt that is going to have to be financed to pay for some of these excesses.

What this crisis has shown is that there is more to emerging-markets growth than just exports. In fact, analysis of gross domestic product data shows domestic growth outpacing exports as a growth driver, particularly in Asia. In addition, the crisis has revealed that policymakers now have an adequate transmission mechanism to stimulate domestic demand through monetary and fiscal policies. These have been fairly aggressive and have, to some extent, worked. Thus, by the end of this year, we are likely to see relatively robust year-on-year growth in places like Brazil, Indonesia, China and India, which have large domestic consumer markets.

It is also important to understand the interplay between the contraction in exports and capital flow dynamics. The deep recession in the western world led to a lasting reduction in demand for Asian and emerging-markets exports, but after an initial contraction, the shift in capital flows has reversed. Equities, syndicated loans and oversubscribed bond issues suggest that capital inflows to emerging markets generally have been increasing significantly and are actually, in many emerging markets, a more dominant driver of growth than exports.

The shift by policymakers toward a domestic demand-led economy is consistent with a stronger exchange rate, which essentially can help transfer wealth to the domestic consumer. We believe that the continuance of a competitive exchange rate is no longer a policy priority in many emerging markets.

The pace of recovery around the world may also have interest-rate implications as many emerging economies with little leverage and sound domestic growth drivers could possibly see higher interest rates, which may feed back to exchange rates. This, in turn, may present some exchange-rate opportunities. We see plenty of potential for Asian currencies and the currencies of commodity producing nations to continue to appreciate. But we are also looking closer at the opportunities that arise from the recent strength of the euro and yen against the U.S. dollar. We are not convinced that conditions are so much worse in the U.S. as to justify such a strong euro or yen.

Please click on the following to find out more:
FTIF - Templeton Asian Bond Fund
FTIF - Templeton Emerging Markets Bond Fund
FTIF - Templeton European Total Return Fund
FTIF - Templeton Global Bond (Euro) Fund
FTIF - Templeton Global Bond Fund
FTIF - Templeton Global Total Return Fund