The Federal Open Market Committee’s (FOMC) two-day meeting begins today. It will decide if it should extend Operation Twist, wherein the Fed sells short-term treasuries, and buys longer-term bonds or if it should partake in stimulus measures to boost a flagging US economy.
Geoff Lewis of JPMorgan Asset Management highly doubts that the Fed will go for a third round of quantitative easing (QE) as he believes the US economy is enjoying a slow recovery. “We think GDP growth will pick-up a bit in the second half of the year to 2.5%,” he says.
He doesn’t think that an announcement by the Federal Reserve that they are going to implement further QE will be enough to generate a sustainable equity rally.
Below is an edited transcript of his interview. Watch the accompanying video for more.
Q: What are your expectations from the FOMC meeting? A lot of people are talking about an extension of Operation Twist. If that comes through, is it sufficient for what the market is pricing in or is the market likely to be disappointed if we just get an extension of Operation Twist and hence there might be a correction in the market?
A: I think the market would be disappointed unless there is something a bit more than Operation Twist. A lot of the Fed’s governors seem to be more dovish recently. What they have been saying in the financial media has raised market expectations. Whether we will see a QE3, I rather tend to doubt because after all the US economic recovery is still proceeding and the Fed would do better to keep its ammunition in reserves.
Q: Are you expecting that they will reiterate Operation Twist and just throw a hint that they stand ready to do other things like quantitative easing?
A: I do not think the case for QE as far as the US alone is concerned at this stage is particularly great. The US is enjoying a recovery. We think GDP growth will pick-up a bit in the second half of the year to 2.5%. There is clear evidence of recovery in the US residential property market. The last set of stats figures were particularly good and this is far from being a jobless recovery although the last one-two data points from the non-farm payrolls have been a little bit disappointing. Nevertheless, the trend is upwards.
There is no great case. Just looking at the path of the positive US recovery, I don’t think the Fed will engage in a further major bout of QE. It seems that the markets are getting hooked on policy operations by the central banks. They are always looking for central banks to come in and do something to boost the market. I think it’s time the Fed said - that’s not necessary justified at this point, we will wait and see. I would much prefer the Fed to stand pat I think.
Q: How do you expect equity markets to move post the FOMC meeting?
A: It is more likely to be a little bit of disappointment if there is further QE. If we look at the historical records, there have been quite sharp rallies and the duration has been less and less after QE1, QE2 and then Operation Twist and the extent of the rally has also been less. I don’t think just an announcement by the Fed that they are going to implement further QE will be enough to generate a sustainable equity rally.
Q: The Dow Jones-UBS Commodity Index was down about 25% in over a year and 5% off in 2012 itself. How do you chart commodities for the rest of 2012?
A: It is natural that commodities have corrected, not just in the risk-off period as global risk appetite has come down but also because of the weaker growth prospects because of the recession that we now have in the European economy. For all these reasons it’s quite normal I think for commodity prices across a broad range of commodities to have corrected in the way that they have done.
At this point I would think the Chinese economy is stabilising, there is going to be a pick-up in infrastructure spending which is commodity intensive in China and the US economic recovery is continuing. I don’t think we are still going to see a further collapse in commodity prices nor do I think we will see a major rally in commodity prices either. So a period of more ranged trading I would think is in store for commodities.
Q: Do you get the sense that perhaps we are in a period of range trading for equity markets? On the downside, do you get a feeling that perhaps that will be protected because all the central banks have indicated that they stand ready to act?
A: Yes, that is quite a likely scenario. Over the summer months, the central banks are in accommodative mode, we know that. The ECB has been waiting for further clarification from the political leaders on things like moving towards closer fiscal integration before it commits more to supporting the markets in Europe but I think that support would be forthcoming.
A lot of bad news is already priced into the markets. The markets could be quite sensitive to a policy surprise. There could be rallies and disappointments and pretty much continuation of the sort of trading we have seen so far this year.
Q: June is not been a bad month at all for India. To some extent it has perhaps coincided with crude also remaining below the USD 100 per barrel mark for Brent. Is there more upside to the market, is the downside protected. How would you chart Indian equities in general for 2012?
A: We are seeing some signs of improvement and the trade data has been a little bit better and oil is coming down and that certainly a tailwind for India. There is still some concern over earnings and margins but also the RBI not only has cut it interest rates it has also been supporting the market by quite heavy intervention purchase in bonds via open market operations (OMO) at an annualised rate equivalent to almost 4% of India’s GDP.
So the RBI is doing its best to support domestic activity. There has been so much disappointment with the government. If the government can get its act together and give a bit more firm leadership then we would be looking at a much better outlook for the Indian stock market in the second half of the year.