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Adam Cole, global head of forex strategy at RBC Capital Markets, says that if ECB’s long term refinance operations figure comes in above market expectations, it will add fuel to the rally in global assets.
Ahead of the day, the expectation was that banks would take up around 500 billion euro said Cole.
Below is an edited transcript of his interview. Also watch the accompanying video.
Q: Hours from now the ECB will announce how much banks have taken from its second LTR operations? What has the market already factored in?
A: I think ahead of the day the expectation was that banks would take up around 500 billion euro from the second tranche of three year LTRO. After today’s money market operations from the ECB we do get some sense that banks were saving collateral so to speak and demand maybe somewhat larger than that. So I think probably an expectation slightly higher than 500 billion euro to 600 or 650 billion euro is probably where the market is now priced.
Q: You are saying that the euro, currently at 1.345 thereabouts, has already discounted 650 billion euro?
A: That would be my expectation; the figure around that size is probably in the price. How the market reacts to that number I think is a slightly contentious issue. My view is that if the banks take up more liquidity than the general expectation, that probably is positive for the euro in the short-term at least because the extra liquidity feeds appetite for risk which would typically be positive for the euro.
Q: If in case the LTRO size comes inline with market expectations of about 500-600 billion euro, how do you expect the rally to be because we have already seen a pretty healthy rally in equities and commodities? Is that likely to continue?
A: That’s my view generally. The more liquidity central bank pours into the system the greater the appetite for risk will be. A figure bigger than the market expects in terms of the LTRO would have that effect yet again. If that’s the case, then typically better appetite for risk tends to be supportive for euro-dollar.
Q: Is there anything in the current environment which worries you, any red flags for the rally? For instance we have seen significant increase in oil prices or the fact that despite so much liquidity coming through ECB apparently not buying too much of sovereign bonds from the secondary market?
A: For the moment we think that the rally goes on and it’s not just the ECB of course that’s fuelling that rally. We have the Bank of England engaged in further rounds of quantitative easing, we have the Fed commitment to keep interest rates at very low levels for extended period, markets pricing in a clear risk but not fully pricing in another round of QE from the Fed. All these factors again are generally supportive of risk appetite.
There is threat emerging in terms of rising crude prices driven by concerns on supply, at the moment at a relatively early stage and it to be seen as a threat rather than part of central scenario and for now my view is that the rally in risk assets can probably go on some further from here.
Q: Speaking of risk assets, would you expect emerging market currencies to continue rallying in 2012?
A: I think so long. Most emerging market currencies versus the G10 currencies typically trade as proxies for general risk as much as they trade on the fundamentals. So, as long as the liquidity injection keeps winning, then that generally will be the case though that trade of course is susceptible to the same risk.
If the rise in oil prices continues for the wrong reasons, for concerns on supply, then emerging market assets will be similarly vulnerable to that.
Q: What are your favourite emerging market currencies? Would the rupee be one of them at all?
A: Generally speaking we are positive on the Asian currencies as a block. I think there are elements of relative value within that, but generally we see outperformance of the Asian currency block against the dollar and the developed market currencies generally.
Within that, if we had to pick a favourite, then it would be probably one of the more liquid currencies such as Korea which is one of investors’ favourite play on the Asia theme generally.
Q: But what about the rupee, you don’t track it or are you sure that it will rally in 2012?
A: To the extent that it could be carried higher by a general rally in Asian currencies across the board then I think look at relative to the external currencies, the developed market currencies generally. You would have to say that part of that is similarly positive trend whether it would one of my picks as to relative value within Asia I have a less strong view on that and I think there are other currencies that are already a play on Asian currency strength.
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