Fed may not cut rates if data stays strong: JF AM

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Geoff Lewis, Head of Investment Services at JF Asset Management believes Fed may not cut rates on September 18 if data stays strong. He rules out a 50 bps cut, Fed may at most cut rates by 25 bps.

He is of the view that the Fed rate cut has already been priced in and markets will be disappointed. The US economy is reasonably strong and he sees a longer period of sub-trend growth. He doesn't see major redemptions in emerging markets and Asian funds.

Excerpts of CNBC-TV18's exclusive interview with Geoff Lewis:

 

Q: What are you expecting to hear from the Fed and what kind of quantum do you expect to see by way of a rate cut?

 

A: I think it is still data dependent. The Fed will be looking for signs that the US economy is begining to feel some impact from the financial crisis. If the data still stays on the strong side, I don't think necessarily we are going to get a cut. We didn't have one from the ECB, we didn't have one from the UK, none that was expected from the UK. But they took the line that economies are still fundamentally, reasonably robust and that the impact is limited to certain sectors, which doesn't justify generally when you think of monetary policy.

 

The Fed has been giving reassurance to investors, one is a cut is definitely priced in. So there will be some disappointment. This is the chance for the Fed how to handle expectations.

 

Q: Just a week back, people were even talking about a rate cut of the magnitude of 50 bps. Have the market come around to believing that at best it will be 25, 50 is not a reasonable expectation?

 

A: I don't think 50 is a reasonable expectation. That would be seen as an admission by the Fed that something really nasty was happening to the economy and would create more of a sense of panic rather than a sense of relief amongst investors. So I have would tend to rule out 50 basis points.

 

I think it is likely that we probably, on balance, will get a 25 basis point cut. But certainly, I don't think we are going to get a 100 basis point cut by next spring that markets were looking for a few weeks back. I think that is more than what has been discounted after the 2001-2002 recession.

 

The US economy is still reasonably strong. The OECD is in the process of revising down its forecast yesterday, and is telling us that there is more likely to be more impact in 2008 than 2007. That's something we will all go along with. There are lags to this mechanism as we know and it might take 0.5% off of US GDP growth next year. So we see a longer period of sub trend growth - that seems to be the outlook for US economy now. 

 

Q: How do you see Asia and emerging markets approaching the September 18. We have had a good rally, do you see the markets approaching it with a more circumspect manner or rallying before the event?

 

A: Basically, we have had a good recovery. Investors are coming to realise that, in a world where markets are unlikely to re-rate, they have to go for where the strong profit growth is, and the strong profit growth is coming through in Asia. We have seen that in most of the second quarter or major results where we have had a record number of upgrades and earnings momentum is looking reasonably strong. Of course, any fallout from sub prime, any weakness in US economy over the next six-nine months will take the edge of some of the exporters, and some of the financial stocks might be impacted a little bit.

 

But the Asian region is basically fundamentally strong, and investors will come back and appreciate that. They will realise that just to drop all traditionally high beta assets is not such a sensible policy in these circumstances.     

 

Q: Just to pick up from what the ECB did yesterday, if there is no rate change but if there is a promise of a bigger dollop of cash for the credit market, do you think the Asian markets might tank a whole lot, fall sentimentally and then recover from there?

 

A: I don't think the European Central Bank actions have such big leverage for Asia. I think people have begin to appreciate that the Asian corporate sector really has strong cash flow, strong cash on the balance sheet and it is not particularly needing to borrow extensively at this point.

 

That is not to say that there won't be some negative impacts from the US economy, but Asia is very well placed to withstand that. I think that's what investors are recognizing these days.

 

We have been quite impressed by the fact that investors are not pulling out of Asian equity funds.

 

Q: Is that what you are seeing anecdotally amongst institutional investors, there's no big ticket redemptions or any fears on their Asian positions or emerging market positions?     

 

A: We are seeing some, but not to the extent that we might have anticipated. So, it does seem to be a little different reaction. The emerging market normally fall they're more volatile at the start of any global financial crisis. This time it was a bit different. They held better for the first phase of the crisis, but then of course, when the hedge funds were forced to sell, they had to sell where their profits were. A lot of those were from their long positions in Asian equity market.

 

We don't see the price movement that have taken place in August as really being terribly meaningful in terms of signals to investors over the longer term. There's been a lot of distressed selling, there's been a lot of panic selling and indiscriminate selling of the equities. So in many cases stock market movements have not really been given us good signals.

 

Q: How have you read this whole rally from the August lows? Do you think it's a relief rally or do you think it was a resumption of a proper longer term up trend?

 

A: I don't think it's very difficult to say. There was certainly an awful lot of panic at first in the credit market, so we had the seizure in the asset backed corporate paper issues, and a lot of problems with investor deciding that they no longer wanted the more illiquid structured products like CDOs which are essentially backed by US residential mortgages, even if those mortgages are high quality trunches.

 

So a counter party risk has become very evident. Even banks are worrying whether they should be doing deals with other banks. That's where the Central Banks can come in and supply liquidity to the markets, and actually ease those fears.

 

So this has been a financial markets problem and not a really an economy problem. Although it's likely to take some of the edge off growth in 2008, because what we will see is something of a tightening of bank lending standards in general. Banks tends to pull in their horns a bit. But it's good that the overall momentum in the global economy is so strong, and there are other areas making enough for the rather flatter picture we've seen in the US over the last 12months in fact.            

 

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