The European Central Bank (ECB) is unlikely to rush normalisation of monetary policy as the macroeconomic backdrop continues to support the status quo, according to Franklin Templeton Investments’ David Zahn. 
As the ECB moves towards withdrawing stimulus by the end of the year, immediate rate hikes aren’t likely to follow, according to the Franklin Templeton head of European fixed income (pictured).
“The ECB is removing [monetary] accommodation but incredibly slowly,” said Zahn, adding that it may even take longer than the central bank had hinted at its most recent meeting.
“Will QE end at the end of the year? Yeah. It’s very unlikely they would go past that [date] now.”
However, Zahn said the idea that policymakers are set to hike rates in the middle of next year was premature.
“There’s no real reason: pricing forecasts are showing inflation at 1.7 per cent in 2020, which means that they probably don’t need to think about raising rates before 2020,” the Franklin Templeton manager said.
Another reason for not rushing normalisation is a slowdown in European growth. Having overtaken the US last year, eurozone economies have experienced weaker growth in 2018. However, Zahn said it was not a serious issue and more likely to be temporary.
Annual inflation rate (per cent) in the euro area and the EU
Source: Eurostat
“Domestic demand has been the main driver of growth in this recovery and it is really domestic funding that has been driving growth and that is also starting to decelerate,” the manager said.
“Exports were never the main driver of growth. Overall exports are important, of course: Europe is a big export-driven economy. But the actual macro growth has been remarkably low.”
Eurozone inflation remains subdued, according to Zahn, posing another potential hurdle for hawks at the ECB. 
While eurozone inflation rose in May to 1.9 per cent up from 1.3 per cent in April, it remains below the ECB’s 2 per cent target and has done for a long period of time.
But with rates at all-time lows, investors will need to act for an environment in which rates begin to rise, according to Zahn.
As such, shorter maturity securities can offer investors better returns in a rising rate environment, particularly as traditional safe have assets – such as bank deposits – provide lower returns.
Zahn said: “People are very defensive and have been defensive for a very long time, especially regarding rising volatility.
“But they’ve been giving up a huge amount of yield to do that, so many of our clients have been short duration for three to four years.”
Another positive for short-dated bonds is their lower volatility relative to other parts of the bond market, according to the manager.
Although volatility picked up in the wake of the Italian elections as uncertainty over how eurosceptic the coalition government would be, Zahn said this was unusual.
“You have to remember that volatility we saw three weeks ago when Italian CDSs [credit default swaps] rose by 150 basis points in a day, that had not happened in a G7 bond market since 1982,” he said.
“That was when [former Federal Reserve chairman Paul] Volcker changed the inflation target and jacked up rates to bring inflation down in the US. It’s a very rare event.”
Zahn, who is also sole manager of the Franklin UK Corporate Bond and Franklin UK Gilt funds, said there could be a further period of change after the UK leaves the EU.
“If you look at the votes that are happening in the EU parliament, the UK has 12 per cent of the votes and non-euro members are about 30 per cent. So, if people want to push things through that non-euro countries don’t like they can block it,” he explained.
“However, once the UK leaves they’ll be left with 20 per cent [share] and it will be 80 per cent for euro countries and it will be much more difficult for non-euro countries [to block legislation]. That will create much more friction with non-euro countries.”
The manager said that the departure of the UK would also have other significant developments for Europe, as this will mean one less larger country voting down big EU budgets.
He said the balance may be tipped in favour of more expansionary budgets as more austere nations such as Germany and smaller states are outvoted, which will be another source of friction.
Indeed, the Franklin Templeton manager said the EU continues to face structural issues. With the ECB having done much of the “heavy lifting”, a good opportunity for reform has not been taken.
Zahn also noted that Brexit negotiations may not be as bad as feared following the Italian election, as one of the largest EU economies returned populist parties to government.
“I think what UK wants is to still have access to Europe and what Europe wants is access to the UK,” he said.
“What people are underestimating is that many countries in Europe will be badly hurt if we have a hard Brexit and no trade deal. They export a lot here. I think they are actively lobbying their own governments.”
The Franklin Templeton European fixed income head was speaking at the launch of two actively-managed exchange traded funds (ETFs): Franklin Liberty Euro Short Maturity UCITS ETF – managed by him – and Franklin Liberty USD Investment Grade Corporate Bond UCITS ETF – managed by Marc Kremer and Shawn Lyons – due to list on the London Stock Exchange on 27 June.
The Franklin Liberty Euro Short Maturity UCITS ETF will invest in European short-term debt securities and investments and will be co-managed by portfolio manager Rod Macphee.
The Franklin Liberty USD Investment Grade Corporate Bond UCITS ETF, meanwhile, will invest in US dollar-denominated corporate debt issued by US and foreign companies. At least 80 per cent will be invested in fixed and floating rate investment grade-debt.
Zahn is a co-manager of the offshore €481.1m Franklin European Total Return fund – the largest of the mandates under his oversight – alongside John Beck.
The fund targets a total investment return made up of combination of interest income, capital appreciation and currency gains, by investing in a portfolio of corporate and sovereign European debt.
Performance of fund vs sector & benchmark over 3yrs
Source: FE Analytics
Over three years the fund has delivered a total return of 27.83 per cent compared with a gain of 29.99 per cent for the Bloomberg Barclays Euro Aggregate index and a 26.71 per cent gain for the average FO Fixed Int – EUR Investment Grade fund.
Additionally, Zahn is co-manager of Franklin Euro Government Bond, Franklin Euro Short Duration Bond, Franklin Euro Short-Term, Franklin European Corporate Bond, Franklin European Income Franklin Global Aggregate Bond and Franklin Global Aggregate Investment Grade Bond.