Investor sentiment weak; USD rally to hit EMs: Barclays

Given the poor macro economic situation, Nick Verdi, Barclays Capital feels investor sentiment will continue to remain weak. He believes if Ben Bernanke fails to give a timeline for tapering off quantitative easing in the FOMC meet today, then dollar will rally which will be a negative for emerging markets (EMs)

Also Read: RBI stance hurting mkt; buying not recommended: Dimensions Speaking to CNBC-TV18 on the Reserve Bank of India's dovish comments on Tuesday, he says the central is unlikely to lower rates anytime soon.  Below is the verbatim transcript of Nick Verdi's interview on CNBC-TV18 Q: Is the rupee getting singled out for punishment or is this looking like an emerging markets (EM) story? A: It is a mixture of both. On Tuesday, we also heard from the Reserve Bank of Australia governor and it was what we have already heard from a lot of G10 central banks which is a form of central guidance. EM central banks are giving another form of guidance that is putting attention on the weaknesses of their currencies. In India, the wider perception yesterday was that Subbarao's statement was a bit dovish. I would rather argue that monetary conditions are actually tightening in India which is being seen as a negative for market and the situation in which the RBI could be in a position to cut rates will be one in which inflation is falling and growth could improve on the back of lower rates. But according to the market, that will not happen anytime soon and as a result the rupee is seeing a selloff. Q: How would you look at the rupee now? It is at 61 and still counting higher for the dollar. At what level would you stop negative bets on the rupee? A: I do not think it is about levels now. It is about action and what happens in the US. Out of India, we not only need to see measures to stop speculative activity, we need to see measures to get inflows back into the country against the backdrop of a world in which the US interest rates are rising. This is why it was damaging that we saw policies to reduce speculation that result in the tightening of policy, but we did not see much on the inflows front and so, it is action that we need to see. We are seeing this across EM as well. Investors who are entering in August, which is notorious due to poor liquidity as Europeans and Americans go on holiday, investors will be very nervous now about entering certain EM markets as we drag through the summer. _PAGEBREAK_ Q: Just in case Ben Bernanke sounds very noncommittal, gives an ambiguous answer and does not give a timeline for quantitative easing (QE) tapering and says it is data dependent, how do you expect the dollar to react and thereafter, the EM movement on the back of just this event? A: Since it is in the night we will not be getting a press conference from Ben Bernanke, so it would just be the statement. There has been a bit of speculation over the past couple of weeks that the Fed would lower its 6.5 percent unemployment threshold which is consistent with an exceptionally low Fed funds rate. I do not think they will lower that threshold. If it is a non-event the dollar can actually rally, so that would be negative for EM. Q: Are you expecting to see outflows from EMs? Would it be debt or equity? A: It depends largely on the market. In India it would be via equities, but in other markets, Malaysia in particular is one market in which foreigners own a big chunk of the government bond market. Today is a big day for bond redemption in Malaysia. We get USD 3 billion redemption today. There are concerns that even strong economies like Malaysia are vulnerable due to currency weakness on the back of outflows. Q: We have seen some fairly strong Indian yields. At least for the shorter term we saw 90 day T-bills going all the way to even 11 percent. Is that not attractive to foreign institutional investor (FII) bond investors? A: It depends on sentiment. At the moment, anything that offers high yield is offering that yield for a reason. If people think that US rates could selloff a little further from here, then people need even more of an incentive when it comes to risk premium and yield. Market participants are looking back to previous rate selloffs in the US and the two examples are 2003 and 1994. It was when rates started to stabilise, when investors were happier getting back into the EM in earnest. Investors are just like companies in consumers. They do not like volatility. If we have to grind higher in yields, that would be much more attractive because people would be able to recalibrate their expectations and then gradually dip their toe back into the market. There is still an expectation that we could get very jerky moves. Q: In an environment of weakening EM currencies if India comes out with a non-resident Indian (NRI) or a sovereign bond how much relief will it provide? Are you expecting one, if yes the quantum? A: If we did see a bond for the Indian market ultimately that would benefit the currency but it really depends on the timing. If something could be announced today and then we get a very hawkish Fed comment, that would not have any positive impact on the rupee. But that should not really be used as a reason to discourage the Indian authorities from coming up with measures to attract inflows. Once we enter a more benign environment and when people are looking at EM currencies and economies again they will be looking at where inflows can come in on the strong side and cover the current account deficit (CAD) that we were worried about.