Dec 01, 2016 04:52 PM IST | Source: CNBC-TV18

Don't see tide turning for EMs on a strong $: Australia Bank

As of now, global investors are a bit cautious on India because they don‘t understand the risks and therefore are unable to plot for the short-term, said Nick Parsons, Head of Research, UK & Europe, National Australia Bank.

Nick Parsons, Head of Research, UK & Europe, National Australia Bank giving a 360 perspective of all the things happening in the World, said the US President-elect has just announced the names of two ministers (Steve Mnuchin and Wilbur Ross) but there are yet no details about his policies.

Markets, he said, would be on tenterhooks till trade policies are announced by US.

On the news of a likely cut in oil production by OPEC, he said any hike in crude price always impacts bond yields – higher the oil price, higher the US bond yields. However, crude is still not close to its earlier high and for that it has to rise another 10 percent.

Higher US bond yields could be bad news for emerging market (EM) corporates. So as of now, it is difficult to see the tide turning for EMs with dollar strength continuing to put pressure on their currencies.

People outside India are watching the whole demonetisation process with fascination and will likely be in a wait-and-watch mode till the process is carried through. If it is successful then it would surely be long-term positive for India.

However, as of now, global investors are a bit cautious on India because they don’t understand the risks and therefore are unable to plot for the short-term.

Below is the transcript of Nick Parsons’ interview to Latha Venkatesh and Sonia Shenoy on CNBC-TV18.

Latha: Let me start with what happened in the US. Trump has announced two ministers, Steven Mnuchin and Wilbur Ross. They have spoken about cutting taxes, etc. How should we interpret these announcements?

A: Cautiously. It would be the short answer to that question. We are beginning to see the names fall into place, but we still know little or nothing about the policies and of course what markets are really going to be on tenterhooks for is news about trade talks and whether or not China is going to be named as a currency manipulator as Mr Trump had promised or threatened during his election campaign. So yes, we know some of the personalities, but it is the policies that markets are really waiting for.

Latha: We got a little more than that. Ross and Mnuchin told CNBC in an exclusive chat that they will look to simplify the Dodd-Frank law. They also said that they will cut taxes for the middle class. So, should that not be equity positive, bank positive?

A: If we look at the banking sector in the United states, the market capitalisation of those major stocks has risen by more than USD 300 billion over the course of the last three weeks alone. So, that gives an indication of the extent to which these slightly more banking friendly policies have already been fully discounted because we had already seen and heard quite a lot of chat around some modifications that were planned for the Dodd-Frank law. So, I would suggest that a lot of that is already in the price and more than fully discounted.

Sonia: The other big event that took place yesterday was the way crude climbed up after the Organisation of Petroleum Exporting Countries (OPEC) has agreed to cut output for the first time in years. How should equity markets receive this news?

A: Crude at the moment, as you mentioned, is up nearly 8 percent on the day, but it only takes us back to where we were on October 30. So, not even close to the year’s highs yet. It would have to rise another 10 percent from current levels to get back to where it has already been this year. I think that the main impact of this is being felt in bond markets. We are already seeing the US 10-year yield up another five basis points today, because of course, higher oil prices are going to lead to higher inflation, one thing that has been absolutely clear throughout the whole quantitative easing (QE) process since the global financial crisis (GFC) is that inflation will not go up until prices do. Now finally, we have got oil prices going up there. The most important of the inflation sub-components, that is going up, it will have a knock-on second round impacts and you would expect that overall, this will lead to some removal of policy accommodation. It will validate the Fed in raising rates and all things equal, the higher the oil price, the higher will bond yields be.

Latha: So, the long developed markets (DM), short emerging markets (EM) trade that has been playing out since the Trump election, should we see more of it?

A: It is going to be difficult for EM to make much headway here other than very selectively on a sectoral basis or country by country. But as an asset class taken together, it is always going to struggle at a time when the US dollar is on the rampage. And that pretty much seems to be where we are at the moment. A higher US bond yields, a higher value for the currency is going to lead to a squeeze for many EM corporates and the fact that we are going to see higher input prices is also going to be a major constraint. So, for the moment, it is difficult to see the tide turning for EM until we see some respite for the currencies. I am a very strong believer that where the currencies lead, the equity markets follow. And for the moment, still it seems that EM currencies are a little bit under the cosh.

Latha: Yes, but we are an exception, are we not? The rupee has been resilient. Therefore let me come to India. How do you see India in the global context and in the light of the recent domestic events?

A: The rupee has been resilient over the course of the last few days, but of course, the shock to the banking system indeed, the whole social and cultural and economic system has been immense over the course of the last few weeks. People are looking on India from abroad with absolute fascination, just wondering if this experiment of demonetisation can be carried through and if it can be executed successfully. And of course, we are watching from a distance without knowing all the day to day difficulties that this is causing. But if it can be executed in a plan, in a way which leads to a much freer and much more modern and well-functioning monetary system, then it can only be something that is a force for the good in the future. The question is getting from here to there and there still seems to be plenty of execution risk. But if it can be pulled off, it will be a clear net-positive for India and for its image globally.

Sonia: Foreign institutional investors (FII) are watching you said. Are they selling out because that is something that we have seen in the Indian markets and do you foresee some more of a sell-out from FIIs?

A: We did see a sharp fall in the currency pushing up towards those all-time highs against the US dollar. It appears and although there has been little or no formal confirmation, it appears there may well have been some intervention which was well-timed, if indeed that were to prove to be the case – and I am choosing my words very carefully there – to the extent that the RBI is very well-respected in international money markets, to the extent that it is able to quell the decline in the currency. That would be a positive sign for the future. And as long as we do not break into fresh all-time highs in dollar-rupee, that will be a source of some support and comfort for local asset markets.

Sonia: So finally, how will you approach India equities now? We have risen just about 3 percent this year versus other markets, like the US rising more than 7-8 percent. What is your approach to our markets?

A: Indian equities approached very cautiously and very selectively. Investors, in this hemisphere and this geography, do not feel at the moment that they necessarily understand the risks, that they find it difficult to plot a short-term course and there is no rewards for bravery in being there too soon. Investors would much rather join the train once it is seen to be pulling out of the station than trying to decide which one to jump on, as it were. I know that that is a rather simplistic metaphor, but right now, investors are playing this very cautiously and very patiently and not really willing to commit fresh capital to that trade.

Nick Parsons
Nick Parsons
Head of Markets Strategy|National Australia Bank
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