Jun 21, 2013, 12.49 PM IST | Source: CNBC-TV18

See 'clear & present danger' from QE tapering: Macquarie

"Those markets that have seen a lot of opportunistic investment flows on the back of stronger, enhance yields are certainly vulnerable to this flight of capital in the next couple of weeks," Richard Gibbs told CNBC-TV18 in an interview.

Richard Gibbs, Global Head, Macquarie Securities feels there is a "clear and present danger" to emerging markets from the tapering strategy of the Federal Reserve.

"Those markets that have seen a lot of opportunistic investment flows on the back of stronger, enhance yields are certainly vulnerable to this flight of capital in the next couple of weeks," he told CNBC-TV18 in an interview.

Below is the edited transcript of his interview with CNBC-TV18:

Q: The big fear in markets like ours is that there is going to be a big exodus in terms of liquidity especially via the exchange-traded fund ( ETF ) route, is that something that you expect to see over the course of the next few weeks, the sharp liquidity outflow?

A: I think that is a clear and present danger from the tapering strategy of the Federal Reserve in the United States (US). It has not just affected like it affected India. It is right through the emerging markets and particularly the emerging markets in Asia where we have seen a lot of that hot money flows. So those markets that have seen a lot of opportunistic investment flows on the back of stronger, enhance yields are certainly vulnerable to this flight of capital if you like and very unstable capital flows in the next couple of weeks.

Q: Do you think this adjustment will be done in the next week or two or are we looking at a prolonged period where emerging markets have to learn to live without kind of support in terms of global inflows that they have over the last 12-18 months?

A: Certainly, we are coming down to a lower equilibrium level of inflows. You are quite right there because we are simply not going to be printing money the way we have been as that tapering starts to take hold and unfold for the Federal Reserve, so I think that will come into play.

But in terms of the actual initial outflows we normally see that in a fairly strong wave in the first couple of weeks and what that has driven by basically is the liquidity of markets.

The more liquidity in the market, the emerging market, the more likely you are to see a strength of capital outflow and that is simply as investors liquidate those very liquid assets, move them back into areas and markets where they think there is greater potential.

Q: All of us nebulously talk about unwinding of carry trades or leverage trades coming off now because of the US bond yield having gone up. Could you explain what exactly is going on with such trades, which are beginning to unwind right now, which maybe putting pressure on near-term outflows?

A: The carry trades really at the end of the day have been inspired by the search for an enhanced yield in jurisdiction outside of the US. So where the US has been printing money or creating money if you like through quantitative easing (QE), it has been producing zero cost money effectively. That money is being taken by investors and exported out of the US to jurisdictions where on a risk-weighted basis there is certainly an opportunity to enhance that yield, as the US now begins to offer better yields itself as those bond yields rise.

There is a prospect in the cash market that the interbank level interest rates will begin to rise as well and obviously as the stock market actually sees sustained earnings growth coming through from a stronger macroeconomic environment then the attraction of investors in terms of exporting that capital into those yield enhancing markets diminishes considerably.

Also, happening of course against the backdrop of some weaker growth in some of those markets including Australia and that means that the prospect for a contraction in the yield differential is also there and that is also going to lead to those outflows out of those markets and back to the US.

Q: Most of the data through the last six-nine months indicated that the flows that were coming into ETFs were more region-specific, so they were either global emerging market ETFs or Asia ETFs. Would you say if there is this flight of capital there will be some kind of discernment that will be made between countries or do you think there will be outflows from all including markets like India? There will really be no differentiation between one market and the other?

A: There will be outflow from all, but there will also within that be greater differentiation as you say and that will be based on basically the strength of the macroeconomic underpinning for each economy and also, the extent to which the outflows that are occurring prove to be destabilising.

If we look at the last couple of weeks where there has been most destabilising, Indonesia is a jurisdiction of course in Asia where the central bank was moved to actually raise the policy rates to try and trap that capital in Indonesia and to discourage the capital outflow. The extent to which other economies pushed into that then that will see the mark down and ironically is likely to lead to an increase in those capital outflows as investors become concerned about macroeconomic fundamentals in those economies.


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