The US Federal Reserve yet again failed to address the issue of quantitative easing, or QE3, while releasing the minutes of its June meeting last week. Market sentiment took a beating, extending the fall in US equities for five straight days.
According to John Woods of Citi Private Bank, the street went into the minutes of the FOMC with high hopes, and the lack of QE3 triggered a sell-off in international markets. He says the Fed clearly specified more action and stimulus, however, the market was only looking for QE3.
Woods says the Fed will pull the QE trigger only if US tended to be quite resilient in recent months and for that reason the Fed remains reasonably cautious and not yet willing to pull the QE trigger,” he explained.
Due to this, Woods says Citi is currently bullish on the dollar. “We expect to see it strength further in the second half of 2013,” he said. On the flip side, he is underweight on equities.
Below is an edited transcript of his interview with Udayan Mukherjee and Mitali Mukherjee.
Q: We didn’t hear much about quantitative easing three (QE3) from the last Fed communication. Do you think we will hear any announcement of that in the Jackson Hole meeting in August?
A: I think the market went into the FOMC minutes with quite a high degree of expectation. The fact that the markets have traded off the day across Asia suggest that expectations were not met. In my view, I think the Fed's speak was fairly direct in terms of suggesting action and stimulus, but those two words don't necessarily mean QE, which obviously the markets are after.
Our general view is that things at the macro economic level have to get a little bit worse before the Fed gets motivated to step in and actually start supporting the markets through the sort of QE initiatives we have seen in previous years. As it stands at the moment we have not yet really seen that substantial and meaningful decline in economic output.
Q: We had six bad days on the trot from the US markets. Given the fact that the macro data has not been supportive and earnings season has not started off well, do you see the possibility of more cuts there?
A: You are absolutely right. There was certainly weakness in the US markets. As I mentioned, US economic data will not be necessarily weak or calamitous, but it is certainly showing some signs of softness. I guess the market is waiting to see whether or not we can pick up in the third quarter, which is seasonally and traditionally a period where we tend to see a slight uptick, or whether or not this soft patch will last for the entire second half (H2). I think that's where the market is somewhat conflicted about.
For that reason, ironically, markets have tended to be quite resilient in recent months. They haven’t fallen anyway like the levels they did this time last year, and for that reason the Fed remains reasonably cautious and not yet willing to pull the QE trigger.
Our view is that the US remains under quite substantial pressure at the moment at the economic level, and at the political level the fiscal cliff risks that we have seen developing over the six months really do put quite a large question mark over their ability to grow.
Q: What kind of investment strategy do you have for the Asian markets? Is your stance different for this part of the world versus the others?
A: As a shop, we are under weight in equities and have been for quite sometime. If you ask me how we are positioned in Asia, I tend to focus on countries that have more of a domestic consumption theme than perhaps those more exposed to export demand in the West. These countries are clearly outperforming and typically they tend to be more in the South-east Asia region.
At a sector level we are defensive, we are conservative. We are focusing much more on the consumer staples and consumer discretionary plays because these sectors tend to perform very well in periods of soft growth and obviously where you have a reasonably robust domestic demand component in your economy, they tend to outperform. So in the equities these are the types of strategies and sectors we are advising our clients and recommending our clients get involved in.
Q: Would you play it differently on the emerging markets (EMs) versus developed markets (DMs) metric because there has been some out performance from some EMs including India?
A: This question about relative performance in terms of DMs and EMs is obviously absolutely critical to this part of the world. In Asia, in general, we tend to live and die by the capital inflows from foreign investors; when these are positive our markets tend to rally and when we have outflows or when they are negative, our markets tend to fall.
Currently we are seeing that a weakness in current account surpluses is supporting a weakness in currencies and that is one of the main reasons investors come here. They come here for the capital appreciation in terms of currencies, and when that is not available, we see capital outflow. That's why our markets have been pretty soft for the last couple of quarters and I suspect that is going to remain that way. In other words, I expect to see a strong dollar enter the second half for as long as this question mark in Europe continues, in China continues and indeed the US growth story.
Q: To sum things up, how would lay out the road map for global markets going into the second half because there is different moving parts now, including what has been coming through from China?
A: Well initially, I think we need to look very closely China. China’s GDP numbers set the scene at least for the next couple of month’s on how we gauge the slowdown, and its impact around the broader Asia region. I think that is the key point we need to look out for.
In eurozone, obviously the ongoing summits will come in every six or so weeks, and expectations will build ahead of them in terms of a meaningful resolution, particularly with yields in Spain, albeit at 6.5% now but likely to take up above 7% if we don’t have meaningful reform. In the US obviously the debate around the so called fiscal cliff will be absolutely critical to setting a growth outlook to the first quarter of next year.