Last night the US Federal Reserve tweaked the language of its statement to say it would be patient in beginning to normalise its monetary policy, even as Fed chief Janet Yellen clarified that the Fed is likely to hold interest rates atleast through the first quarter of 2015.
Stephane Deo, global head of asset allocation at UBS expects to see interest rate hike in the middle of next year – around June.
The Fed is primarily watching inflation and wages (labour market) and if any one of the two deteriorates then the wait for rate hike can get longer, but not too long, he adds.
Below is the verbatim transcript of Stephane Deo’s interview with CNBC-TV18’s Menaka Doshi and Anuj Singhal.
Menaka: What did you make of the minor change in language in the Fed’s statement? Does this mean that rates will go up or start moving up by mid 2015 which had been the expectation even before we heard from the FOMC last night?
A: Yes, that is our expectation. We think the first rate hike will come in June. As you said there is very much consensus among economies but it is not priced by the curve at all. You should look at the forward, the pricing they are few basis points. So very low probability of a rate hike in June. Going back to what you were saying about the message of the Fed, it actually looks very similar to what we saw in 2004. The Fed said ‘considerable time’ four times in a row then you want to be ‘patient’ for two meeting, then signal a hike and then a move.
So the pattern for the time being is extremely similar to 2004 and that is consistent to the first rate hike in the middle of next year, probably June because there is a press conference.
Menaka: It was in January 2004 when they first introduced the word patient in their commentary. They reiterated that in March and they moved rates up in June 2004. So that is six months from the first time they used ‘patient’ and three months from the second time that they used ‘patient’. That sort of fits in with your estimation of a rate hike in June?
A: That is correct and again if you look at what the FOMC is telling us even Dudley who is on the dovish side of the FOMC said a few weeks ago that the right scenario for him would be a rate hike in the middle of the year. So, even the dovish side of the FOMC meeting is signaling a rate hike by June.
Again you have to keep in mind that they will have to move the Fed funds with other rates like the deposit rates. So, probably the first move, they will want to have is a press conference to explain everything. So, June is a very good candidate from my point of view for the first rate hike.
Menaka: Is this assessment of yours and this seems to be the consensus’ assessment sort of in sync with what went on in the bond markets yesterday because we in fact did see the 10 year yield move up a wee bit to 2.1 percent this even though we have got some very negative data on inflation from the US which is another fall of 0.3 percent?
A: Yes, the curve has steepened, that is true but actually I am checking as we speak. If you look at the Fed fund contract for June it has not moved at all. So, basically even with the slight tweak in the communication, the curve is still pricing something like 17 basis points. So it is basically saying that rates will not move from where they are right now. There is a risk at some point that you have a big movement on the short part of the curve.
Menaka: I am just curious to know as to what could change this consensus’ estimate. For instance if crude prices go from between USD 55/barrel to USD 60/barrel all the way down to, let’s say, USD 45/barrel which is the worst case scenario that some brokerage reports came out with, do you think that would push out even further potential hike in interest rates by the Fed?
A: It is possible, you have to keep in mind that the Fed has been very consistent in saying A: that they target core inflation and B: in saying that wages are the main component of core inflation. So even if you see the headline going down because of oil price, they are going to say while we don’t control oil price, we don’t control commodity price which is really important is the labour market and as long as you a very clear sign that wages are increasing not very clearly strongly but they are increasing, I think it says you have to remain intact. Now, if oil prices really fall enormously as you were explaining then obviously top line inflation will remain low. So you could wait for a little bit longer but not much longer.
Menaka: What does this mean for global fund flows, for global equity markets especially from the emerging market point of view what would it mean for a market like India?
A: For a market like India could possibly speaking would perform well in the end but I am worried in this kind of scenario if you give me oil price really low or commodity price really low that means that is negative shock for the income statement of many emerging market (EM) countries. If at the same time interest rates are going up that is bad news for the same country which are really leveraged and etc and again is not the case of India benefit from lower oil price but I am very worried about the income statement and the interest cost for a number of EM countries. They could suffer a lot in this kind of situation because at the same time they have less revenue and more interest payment. So that would be very bad for the EM countries in total. Again, India is probably a good example in that case.