Coordinated policy action from EU policymakers likely: RBS

With the European summit underway, Imran Zaheer Ahmad, Global EM Strategist, RBS expects to see coordinated policy response from EU policymakers. In his view, asset markets are not pricing in a positive outlook from the EU summit.

“There is room for disappointment from the summit. But this negative risk backdrop that we have in the market at the moment is likely to persist. We are still seeing global equity markets come under pressure, we are seeing a bid for the dollar, emerging market currencies under pressure and commodity prices still look like they are heading lower,” warned Ahmad.

Ahmad cautioned that the overall concerns in the global economy are still high and lingering concerns of Europe slipping into recession persist. He added that growth is seen moderating in Brazil, India and China.

Below is an edited transcript of his interview. Also watch the accompanying video.

Q: What are equity, bond and commodity markets discounting or pricing in terms of expectations from the European Summit?

A: At the moment, in terms of the European Summit, there has been some anticipation that we might get some coordinated policy response from European policymakers to address the problems that we are seeing in Greece and some of the other periphery countries. But I don't think that asset markets are pricing in a hugely optimistic outlook from the Summit given the fact that they have been disappointed on so many other occasions.

Q: What do you think the summit can realistically deliver given the political constraints, especially in Germany?

A: The big concern that the market has got is even though the policy measures that are needed for Europe are perhaps actually relatively straightforward in terms of Pan-European deposit scheme, in terms of extra liquidity for the markets, a growth compact to decide how we can get renewed growth and competitiveness in some of the periphery countries.

The big challenge is that the political cycle in countries such as Germany just means that it is very difficult for policymakers to actually make the right decisions. I think that’s what lies behind some of the real market skepticism that we are seeing coupled with some of the broader problems that we are seeing in the global economy, in particular in some of the BRIC economies, which are going through a very sharp slowdown.

Q: How do you expect the markets to move from Monday?

A: Overall, the concerns in terms of the global economy are still very, very high. We are seeing slightly better data from the US, but overall it’s still very modest recovery in the US economy. Concerns about Europe going into recession despite what outcomes we get from the summit and then we have got a bit moderation in growth from Brazil, from India from China as well. I think there is room for disappointment from the summit. But this negative risk backdrop that we have in the market at the moment is likely to persist. We are still seeing global equity markets come under pressure, we are seeing a bid for the dollar, emerging market currencies are still under pressure and commodity prices still look like they are heading lower.

Q: You spoke about moderation in growth coming through from the China, Brazil. Will low growth be the big theme of the next quarter? Would that mean that we are likely to see more falls in risk assets? For instance, would crude average below USD 90 per barrel mark?

A: The commodity story has been very significantly driven by the strong China growth story and earlier this year, we have seen the cracks in the China story. We have seen policymakers coming back and respond by cutting reserve requirements by cutting the policy rate. But it’s still very uncertain whether there is actually going to be stronger growth coming in the 3rd or 4th quarter of this year in China absent of a large fiscal stimulus package from China. Therefore, in terms of the commodity outlook, there is downside pressure.

We don't see oil coming down materially partly because Saudi Arabia has what would like oil relatively high levels especially given a lot of a fiscal expenditure programs following the Arab spring. For some of the other commodities in terms of base metal, the fundamental story for commodities is relatively robust. In particular, world demand has stayed relatively constant what we have seen is a supply closure in certain places, which is keeping some pressure on commodity prices.

In terms of the soft commodity space, we have seen a very mixed picture in terms of commodity prices. I would say that the one big positive from the slightly lower commodity prices is that inflation across emerging markets is coming down significantly. This provides room for a policy easing from central banks across the world. We have seen aggressive cuts in Brazil, 400 basis points in India and in other emerging markets and the hope is that these cuts then lead to stronger growth as we go into the end of the year.

Q: What should smart money chase during the next six months of 2012?

A: At the moment, in terms of smart money, we are finding is very low conviction levels. While we have still got so many of the global macro risks, investors are being very hesitant in terms of dipping their toes into markets. For the brave and those that believe in the long-term emerging markets story, the weakness that we are seeing at the moment and any further weakness that we might see are likely to be a great buying opportunity in terms of local currency space, in terms of EM equities as well.

The other trade where we are seeing a significant interest is exposure to EM bond markets. With growth coming down and inflation falling, there is a lot of scope for central banks to ease policy and so receiving rates and being long emerging market bonds seems to offer this attractive medium-risk medium-return asset class that continues to lure investors.

Q: What’s your take on Indian equities and Indian currency?

A: In terms of the India story, we have been talking for a long time about the triple deficits in India - the current account deficit, the fiscal deficit and the policy deficit. But what we are seeing is that with the measures that the government is imposing in terms of the currency market are being extremely ineffective and they are not powerful enough to provide support for the INR. So our view is that the INR is likely to continue to be on the range bound or weakening trend.

We don't think that we have seen the worst of this and we need to see policymakers come up with more aggressive action to stem the weakness we are seeing in the currency. In terms of the equity market again, this comes back to the growth outlook. We had the first quarter GDP number which was at 9-year low and overall the data has been relatively weak since then as well. We are now talking about growth in India around 5-6%, but we are used to growth close to double digits.

So the equity market outlook is also relatively negative partly because a huge amount of inflows have gone into equity market. Just since the beginning of this year, we have seen about USD 8 billion into the India equity market. This has gone in because valuations are very cheap, but if growth continues to slide then there is a risk that some of the money will also exit from the India equity market.