Jul 03, 2013 07:04 PM IST | Source: CNBC-TV18

Like EM defensives; see more pain for currencies: Macquarie

Richard Gibbs, global head, Macquarie Securities says the current corrections seen in the global market is due to two major risks- the geopolitical crises in Middle East and the economic risk coming from the United States on the back of tapering of the quantitative easing(QE).

Richard Gibbs, global head, Macquarie Securities is overweight on defensives in emerging market (EMs) particularly India. Global markets are now exposed to two key risks- geopolitical crises in Middle East and tapering of quantitative easing (QE) by Fed, he told CNBC-TV8 in an interview.

Investors would be closely watching US payrolls data that will be announced on July 5, it will be a cue towards the changing economic conditions, he added.

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Gibbs, however, adds that EMs' currencies are likely to be hammered more. "Investors are looking for US dollar exposure and US dollar denominated assets and particularly risk assets on the capital growth side. Hence, I have to buy US dollars to really get that exposure. This means that currencies that have actually fared very well against a depleted US dollar in terms of value and support during the height of the QE operations are now going to start to suffer as that capital is mobile and it moves out of those exchange rate exposures," he explains.

Below is the edited transcript of Gibbs' interview to CNBC-TV18.

Q: We had temporary relief for some global markets, but it seems to be coming unstuck again. What is it that you hear is driving this performance? Have the pullouts begun again from emerging markets (EM)? Is it something else?

A: Two major waves of risk are coming into play for the markets in an unwelcome way. First one of course is the geopolitical risk which is escalating in the Middle East of course in and around Egypt and there is more conflict and strife going on there. We are just not sure where that is going to head. That has been driving up oil prices and other energy prices in the market.

Secondly, we have the economic risk coming from the United States with potentially some mixed signals from senior Fed officials in relation to this wind back or tapering of the Quantitative Easing (QE) operations.

Q: The fear has been since the first correction came through that a lot of the money now flows back to the mother market. Is that something you are hearing and seeing anecdotally that consistently money is being pulled out in favour of US equities?

A: It certainly is and it is going to be really chasing capital growth now whereas previously, the emphasis was on yield, yield enhancement, Indian market and another EMs, high yielding markets fared very well in that environment. The mindset of investors is changing, the psyche is changing and it is being driven to change by what the Fed is saying in relation to the QE operations and the potential tapering of those operations. So, they are talking the growth story up. They are talking the prospect of capital growth in investment up and the United States market is the key destination for that.

Q: There were some soothing noises made over the last week or so indicating that perhaps the taper would not happen as soon as markets feared and that it would be a very, very gradual process. How much stake would you put in that and by extension of that how would you approach this current weakness in equities?

A: I will put a great deal of emphasis on that. Those comments were not from some minor person; that was from Bill Dudley, president, New York Fed and a member of the Board of Governors, and is a very experienced economist and a former colleague of mine. He was reminding us that of course the tapering of QE is not depended on the calendar, it is dependent on the economic outcomes and the economic performance of the US economy.

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This means the payrolls on July 5, after Independence Day holiday in the United States, assumes even greater significance because the Fed has said that it wants to see that unemployment rate driving down before it really moves to fully exit the QE operations.

Q: Tactically how would you approach the EMs in specific, markets like India in that context?

A: We are going to continue to be exposed on the equities side and we should be and are looking to be in defensive. We have to play these as a defensive market episode. That means keeping a bit of a yield enhancement emphasis in terms of the capital deployment in the EMs even though in the advance markets led by the United States we are looking to that capital growth side and we are looking for those cyclical growth stocks in that area. So, I would still be looking to be overweight defensives now in the EMs and in particular in India. Hence, we will just bid down our positions until we get a clearer indication of where the global economy is headed and also the United States in terms of this tapering of QE.

Q: Would you expect this correction in EMs to also create a further rout in EM currencies, something that we experienced all through the month of June?

A: I think certainly that is the case. There is no question that the US dollar is going to continue to trade higher. Investors are looking for US dollar exposure and US dollar denominated assets and particularly risk assets on the capital growth side. This means I have got to buy US dollars to really get that exposure and that means that currencies that have actually fared very well against a depleted US dollar in terms of value and support during the height of the QE operations are now going to start to suffer as that capital is mobile and it moves out of those exchange rate exposures.

The extend to which that is complicated by the geopolitical risk factors that are coming into play remains to be seen, but at the end of the day, the broad portfolio shift continues to be in progress and that is likely to see further mark downs on this emerging economy exchange rates.

Q: What you are seeing happening across some of the bond markets in these countries? That as well has been a source of great pressure. India has not seen the bond outflows some other markets have. Do you see that continuing?

A: That is a clear and present danger and we see through Association of Southeast Asian Nations (ASEAN) in particular, we may see more bond outflows occurring. The United States Pacific Investment Management’s (PIMCO) soaring June record outflows or withdrawals from their major bond fund as well have been seen. Hence, it is occurring across the globe as investors are going through that change in mindset and I think that is a clear and present danger for those emerging economies where there may have been a bond market bubble in process at the time of the talk of the tapering of QE. I think they are vulnerable to those kinds of movements.

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