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Early Fed rate hike no catastrophe for EMs: UBS Invst Bank

In an interview to CNBC-TV18’s Sonia Shenoy and Senthil Chengalvarayan, Ramin Nakisa, Senior Global Asset Allocation Strategist, UBS Investment Bank gave his view on whether an earlier-than-anticipated Fed rate hike is on its way. He also spoke about his reading of emerging markets and India in particular.

Below is a verbatim transcript of the interview

Sonia: The investors are looking out for two magical words which is “considerable time”. The omission of that phrase could indicate that perhaps an interest rate hike could come in sooner than expected. What is your sense of whether this “considerable time” language will hold in this policy or will we get an indication of when the rate hikes can come?

A: Our central case is still that the first rate hike is going to be in the middle of next year. So, expecting a big policy shift at this point is fairly unlikely. However if you look at the dot plots and plug that into Taylor rule, what we see is that the Fed forward guidance is completely at odds with what the market is pricing and with their own forecast about the economy is pricing. In other words there is a kind of big mismatch. What we are concerned about is that there could be a jump up in yields, another kind of taper tantrum once markets adjust. So, that is the main concern at the moment this mismatch between what the markets are pricing and what the Fed’s forward guidance is telling us.

Senthil: You are expecting a hike only in mid March but the market will be looking for signals and may completely misread signals or look for signals but there are no signals. So, that is a concern to you?

A: Certainly and what worries us is about a very sharp adjustment in rates because if you look back over history if you go into a hiking cycle with low inflation at low rates typically that has been very good for equities because you are moving away from deflation. So, that could be a very good scenario for equity. What worries me is that we are going to see a very sharp rise in rates. That kind of thing can’t be absorbed by the equity market and that would promote a kind of risk off environment which would be bad for equity.

So, our central case is still going to be that the Fed will steer the course properly and that they won’t cause this taper tantrum. However, a risk case is that we do see a very sharp adjustment and that would be a concern. Obviously, volatility would increase in all assets if that were the case and also we would see a sell-off in risk assets and high beta assets such as the yen.

Sonia: If your risk case plays out, then what could the near-term impact be on emerging markets? Do you just see a knee-jerk reaction where the extent of the downside could be about 5-10 percent at worst or do you think we could be in for a time wise correction in this market?

A: I think it will be more of a kind of 10 percent correction. This is not going to be a catastrophe because markets have been considering this rate hike for a very long time. The more people talk about it lesser the shock we will have if there is a change in language. More gradually, a kind of strategic view from us is that the dollar is going to strengthen obviously that will be bad for emerging markets, yields in the US are going to rise again – bad for EM. So, strategically it doesn’t look particularly positive.

However, having said that at the moment the flows are still very positive. We have seen 5 consecutive months of EM equity inflows and that hasn’t stopped even though we have seen a de-risking in developed markets. EM is still seeing inflows in the ETF market. So, I wouldn’t rule out the possibility of kind of further upside for EM in the next 3-4 months unless we see a very sharp change in policy from the Fed.

Sonia: When you say further upside in emerging markets what would your view be on India as a market because we have seen a considerable amount of outperformance, we are up almost 28 percent year to date. We have been the best performing market. Do you think that outperformance will come to an end now or will that continue?

A: There is an article in the FT today about Modi’s honeymoon period ending because we haven’t seen the reforms with that momentum that swept him into office. He has had four months now and we haven’t seen any kind of major structural improvement, particularly in the infrastructure of India. There was a comparison between expenditure on telecom networks in India versus China. It is just one tenth of the investment over the last year. So, we have to see those structural reforms panning out.

Having said that, there is a lot going for India. The demographics are very positive and as you said it has been a very well performing market over the last six months or so. So, it still would be one of our preferred markets. We like North Asia. We like India and the flows have been rewarding in India for the kind of election results but whether that continues will depend on what we see with the structural reforms.


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