Apr 25, 2012 05:17 PM IST | Source: CNBC-TV18

Barclays Cap sees dovish FOMC; euro may touch 1.20 in 1-yr

The US markets closed mixed, ending off their session highs ahead of the FOMC meeting announcement. Nick Verdi of Barclays Capital tells CNBC-TV18 that markets will be expecting a dovish statement from the meeting.

The US markets closed mixed, ending off their session highs ahead of the FOMC meeting announcement. Markets will be looking for the Federal Reserve's economic assessment and clues to future policy, including the probability of a third round of quantitative easing (QE), when it concludes its two-day policy meeting later on Wednesday.

Nick Verdi of Barclays Capital tells CNBC-TV18 that markets will be expecting a dovish statement from the meeting and adds, "We think that the outcome of the FOMC will mean probably high yields in the fixed incomes space and a stronger dollar tonight."

Below is an edited transcript of his interview. Watch the accompanying video for more.

Q: Will there be hints of quantitative easing? What will you watch for and what do you expect from the FOMC?

A: If you start by what the treasury market is expecting, at two year yields remain very low. If you move further out on the yield curve in the US, the rates are very low. I would say on the back of that, markets will be expecting a dovish statement from the FOMC. Key points to watch are the FOMC’s latest forecast on growth and inflation and whether it continues to stick with its promise to keep rates low until the medium-term.

We think that the market will be a little disappointed by the FOMC. We are not looking out for a particularly dovish statement. Comments from Ben Bernanke and Janet Yellen have allowed the markets into thinking that we will get dovish statements today but that isn’t our expectation. We think that the outcome of the FOMC will mean probably high yields in the fixed incomes space and a stronger dollar tonight.

Q: There are some experts who have said that the euro’s persistent ability to stay above 1.31 for the better part and 1.30 almost entirely for this year is surprising and that it should slip below. Would this be the catalyst that pushes it down? Where do you see the euro-dollar in the next four weeks?

A: We have got a modest grind lower over the next couple of weeks in the high 1.20s but a significant move lower in the near-term looks unlikely. If you think about the reasons why the euro has held up despite all of that bad news, it’s because a lot of the exiting from European bond markets by non-European investors that is probably behind us for the time being.

I think politics will not be the key driver in terms of getting the euro down from here. We are looking for euro-dollar to fall to 1.20 in 12 month’s time but we think this will be primarily on the back of macro economic fundamentals rather than politics.

In the next couple of weeks we do see a lot of event risks in terms of the second round of French elections, we have the Greek elections as well as the deadline for the European Commission wanting to see the budget deficit projections from individual members. Until we see clearer signs that the euro economy is underperforming the US significantly, only then will we see the euro break some key technical levels.

Q: If your forecast on the euro-dollar is 1.20 at the end of four months what would it do perhaps to some other weaker currencies like the rupee because that has underperformed even most of emerging markets?

A: We are looking for the euro-dollar to get to 1.20 in 12 months time. For the dollar-rupee we are looking for a modest move lower. So, in 12 months we can get it down to around 48. We are positive Asian currencies but in this environment, until we move over the speed bump from risk in Europe, Asian currencies will struggle to appreciate significantly.

Once we do get through these next four months and the economic outlook for the US in particular does become clearer, it will become evident that North Asia in particular is able to take advantage of the fact that the US is continuing to grow well.

In terms of how the rupee does in that environment, we do think it will appreciate as some of the concerns that we had earlier in the year starts to abate, particularly, high interest rates inhibiting investment growth for example. That said, while we do expect the dollar-rupee to move lower it will underperform its peers in the region, particularly, North Asian currencies such as the Taiwan dollar and the Korean won.

Q: What do you expect it to do before that perhaps expected appreciation happens? There are people who are calling for 55 to the dollar and there are people who are even calling for lower levels for the INR. What are you looking at?

A: We think we are pretty much topped out in terms of dollar-rupee. I think a lot of bad news is priced in and in order to get up to a level such as 55, which isn’t out of the question, you would have to see some specific event risk that is happening to India. So I think a move up to 55 would encompass a significant underperformance versus the rest of the region. One factor that could take us up there would be if inflation isn’t able to fall and the central bank isn’t able to deliver on monetary easing but that isn’t our central case.

Q: What is your quick forecast on where do you see the dollar index?

A: On dollar index itself we haven’t got a specific forecast. We are looking for fairly broad based dollar strengths. So, the dollar-yen for example, to climb to around the 90 level in 12 months time. We are looking for some broad based dollar strength particularly on the G10 side.

Q: In the first two and half months, we did see a significant inflow of investor money probably because of the LTRO into India and to most risk assets. We have seen that petering off and practically nothing happening for the last six weeks or so. Do you see more money flowing in at the latter part of the year?

A: What we have to see in order for more money to come in here is for Europe now to be less of an issue. It will remain with us as a problem for the next couple of years as these countries try and restructure their public debt but in terms of it causing contagion to financial markets, the LTRO has done a very, very good job in helping to assuage market concerns.

As we move into the second half of the year, it will become clear that there is significant momentum particularly in North Asia and that will feed through to the rest of the region and make offshore investors more comfortable investing in the region.

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