US deficits, not de-dollarisation, reshaping bond markets: Franklin Templeton

[SINGAPORE] Fears of global de-dollarisation are vastly overblown, with persistent US fiscal deficits and de-globalisation posing a far more significant long-term challenge for bond markets, said Sonal Desai, chief investment officer of Franklin Templeton Fixed Income.

She told The Business Times in an exclusive interview that, despite concerns over tariffs and geopolitics, global investors continue to view US assets favourably.

“Financial advisers will go to where they believe returns are. We found out that at the end of last year we had close to record inflows into the US,” she noted, disclosing that the sum totalled US$1.7 trillion.

Desai attributed the weakness of the US dollar in 2025 to profit-taking in equities; Germany easing strict government borrowing limits to boost fiscal spending; and tariffs, but described the sharp currency depreciation as an outlier and said a repeat is “highly unlikely”.

She added that some dollar softness is perfectly consistent with global reserve currency status.

Fiscal deficits and de-globalisation

She highlighted forces that are likely to have a more lasting impact on bond markets, such as persistent US fiscal spending and de-globalisation, which will keep inflation sticky and push interest rates higher than markets expect.

This comes as the US economy remains robust with the labour market remaining resilient, added Desai.

“It is the first year the market seems to actually be paying some attention, but it is the sixth year that the US has been running enormous fiscal deficits,” she said.

However, Desai clarified that this does not mean that US debt has hit an immediate tipping point. While nominal deficits have remained large in recent years, stronger economic growth has helped to stabilise debt-to-gross domestic product ratios, giving the US more room than many other economies.

“That does not mean it is not a problem; it just means that the US has a bit more time than some other countries on this front.”

Desai also rejected the notion that the US is trapped in an unequal “K-shaped” divergence, where richer households have been earning and spending more while poorer households suffer shrinking incomes and consumption.

Instead, she described US growth as an “upward-tilted E”, where everyone’s income is growing but the richest grow faster.

Beyond fiscal deficits, de-globalisation could bring about more inflationary pressure driven by energy transition and also “near-shoring” – the shifting of supply chains to geographically closer neighbours.

“Everyone agrees that renewables are a good thing. It is inflationary in the short term and inflationary in the transition term, which might last a decade or longer,” she said.

On “near-shoring”, she noted that it was an inevitable trend, especially after Covid-19, when there was the realisation that supply chains were not as resilient.

“That is a trend which is not going to reverse,” she added.

Fixed-income opportunities

Against this backdrop, Desai said investors should be cautious about making aggressive bets on falling interest rates.

While the US Federal Reserve frequently frames current Fed fund rates as moderately contractionary or restrictive, Desai views the environment as moderately expansionary, estimating that the neutral funds rate is closer to 4.25 per cent.

This 4.25 per cent estimate assumes inflation at around 2 per cent and productivity growth around 2.25 per cent – contrasting with the Fed’s longer-term projections of around 3 per cent.

She sees no need to take massive bets on duration right now, saying that observers should focus on active, highly selective allocations with a strict short-duration bias.

Based on that view, she does not see current 10-year Treasury yields of around 4.4 per cent as particularly compelling.

Regionally, Desai sees little value in Asia due to the ongoing Iran crisis, noting that India, Thailand, Indonesia and the Philippines are particularly vulnerable because of their current account deficits and heavy dependence on imported energy.

Instead, she finds better opportunities in Latin America, which appears less affected by fluctuating fuel prices.

She added that while corporate credit spreads remain historically tight, overall yields remain attractive.

“You just have to be very active, and you have to choose your positions and recognise that you are not going to get spread compression,” she noted. “You might even get a little spread widening, but the coupon is attractive.”