June-like sell-off likely if Fed tapers QE on Sept 18: UBS

The Fed tapering its bond buying program, though inevitable, will cause serious repercussions in emerging markets (EMs), says Ramin Nakisa, senior global asset allocation strategist, UBS Investment Bank.

Also read: To taper or not taper: Jobs scrutinised for next Fed move
Speaking to CNCB-TV18, Nakisa adds that the tapering will lead to another June-like market crash.
"We will see a short sell off of risk, investors should use that opportunity to go more overweight in developed markets. Infact our preference would be for Europe and UK. We have an equal overweight US, UK and Europe at the moment. A clear developed market over emerging market preference," he adds. Below is the edited transcript of Nakisa’s interview to CNBC-TV18. Q: Is there anything important in the European Central Bank (ECB) and the Bank of England (BOE) announcements that you will watch out for – that the market will react to?
A: What we are really watching is the Fed and I think something that we are worried about is policy contagion, which is the fact that when the US hikes generally yield curves all across the world tend to go up in sympathy. We saw two days of correlation after the Fed just hinted that it was going to taper. So, I think we should see that again coming up to the September 18 announcement which we expect to be the first announcement of tapering.
So, there is less importance on BOE, maybe ECB will be marginally more important, but all eyes are on the Fed at the moment. Q: What are you expecting from the jobs data tomorrow and the September 18 meeting?
A: We are on the final glide path to tapering and we might encounter some turbulence but we are not going to abort the landing because of the payrolls numbers.
We are expecting a reasonable number, but it is fairly inevitable. We will see tapering soon and it is quite right for the US to do that. I don’t think they are concerned about emerging markets (EMs) when they make that decision.
They have to act in best interests and I am not sure that they believe that there will be repercussions in emerging markets which will affect their own market. So, they will go ahead with it. It will be fairly quick. It could be over by June next year. The tapering could be reduced to zero as they purchased it very quickly.
They may have a choice of assets which they choose to taper first, so, they may delay the mortgage-backed securities (MBS) tapering because they want to keep the housing market recovery intact and they want to keep funding costs lower for mortgages but we were certainly expecting spikes in the treasury rate, we are expecting yield curve spikes globally in sympathy. Q: Could things be completely thrown off track because of the Syria developments which could escalate next week?
A: Our oil strategist tell us that we may see spike in oil say up to USD 150 per barrel which would be quite shocking. In fact just yesterday we went overweight energy in our asset allocation portfolio. We put on a small overweight because we think that the effect will be fairly short and sharp. So, that won't necessarily have an immediate impact on risk assets.
However in terms of regional escalation, that is obviously the concern because if Iran retaliates for example that could be potentially disastrous. Q: How is UBS approaching India in light of the possibility that Brent could rise as well as the FOMC policy?
A: Looking at the Sensex this morning – it is incredible, it is up 5.7 percent since its low about 11 days ago.
However, if one looks at the rupee that has kind of stabilised since governor Raghuram Rajan took office. Currently it is around 66 and the volatility is still highly elevated for the rupee. We are still concerned about structural problems in emerging markets particularly in the high current account deficit (CAD). I think the really toxic combination is when you we have a high loan to deposit ratio combined with CAD because that is the kind of recipe for credit crunch.
The two worst countries on that measure are Indonesia and Thailand, but I think India also has a high loan to deposit ratio at the moment. Q: Do you think that when the tapering actually gets announced on September 18 we could see some more violent moving out of funds especially from India?
A: Absolutely. We will see a repeat of what we saw in June but more so. We will see a more exaggerated sell off in treasuries, we will see yield curves globally move up and we will see a move out of risk assets.
However, what happened in June was risk assets recovered very quickly, treasuries didn’t recover at all.
So, we will see a replay of that. We will see a short sell off of risk, investors should use that opportunity to go more overweight in developed markets. Infact our preference would be for Europe and UK. We have an equal overweight US, UK and Europe at the moment. A clear developed market over emerging market preference. Q: Do you think in this next rout that you expect and in forthcoming capital movements out of the country, could the Nifty could go to as low as 4800? Do you have any level in mind?
A: We don’t generally think about the Indian markets in particular, but generally we are structurally bearish on emerging markets particularly over the longer-term. Our main concern is that we are seeing margins being eroded by increasing unit labour costs and that seems to be a structural problem across emerging markets.
So, if one looks at return on equity in developed versus emerging markets that seems to be not so favourable what it used to be. That is our major concern about India but also emerging markets generally.