Fiscal cliff US-specific event; Re won't be hit: Barclays

In an interview to CNBC-TV18, Nick Verdi, currency strategist, Barclays Capital says the market's rally has been a risk rally and it is now unwinding. "What we have seen over the past two months in the run-up to the end of the year, has really been a risk rally. I think we are seeing somewhat of an unwinding of that, particularly related to the fact that the fiscal cliff will soon be upon us," he says.

Verdi also adds that the rupee is under-performing due to its high-beta state and won't be largely affected by the US fiscal cliff. He says, "It is not that this is not going to be negative for market. I just think that we will not see an outsized response from the rupee, because this will be very much a US specific event. It will be those countries that are more levered to the US that will suffer."

Also read: Rupee falls, seen in tight band

Below is the edited transcript of Verdi's interview to CNBC-TV18.

Q: Rupee has always been high-beta, but what explains this under-performance in the past week or so?

A: It is largely down to its high-beta state. What we have seen over the past two months in the run-up to the end of the year, has really been a risk rally. I think we are seeing somewhat of an unwinding of that, particularly related to the fact that the fiscal cliff will soon be upon us. Rupee is one of those currencies that is high beta and is under-performing as a result. We should remember that volumes at this time of year are exceptionally light which means that very small moving volumes can cause outsized changes in price.

Q: What is the guess in the market about the risk rally itself? Does the fiscal cliff and uncertainty over its resolution pretty much dog the market for a goodish bit? Or do you think that when the solution nears, you could see a brilliant resurgence or a big resurgence of the risk rally? How are you basically looking at January atleast, if not further down?
A: Next year we are pretty constructive on risky assets, but the real problem is the fiscal cliff. I think markets up until now have been petty complacent about the fiscal cliff and that is being caused by liquidity created by quantities easing by the big G10 central banks. That in turn, has lead markets to perhaps under-price some of the risks. The deadline for the fiscal cliff is December 31 and our view is that we will head over the cliff and that will lead to some immediate fiscal tightening in the US.
I think the risk rally that we have seen into year-end will then come to an end and then, asset prices will have to come off for a couple of weeks before investors dip their toes back in the water and take risk on again. However, I think the first couple of weeks of the year will be negative for risky assets.

Q: Hypothetically, just in case the fiscal cliff resolution does not take place by December 31, then what might be the reaction in the currency market, particularly with respect to the dollar index as well as the euro?
A: That is actually our central view. We think that we would go over the cliff and in that case, you are looking at currencies which are heavily levered towards the US economy suffer. So, in the first instance the likes of the Mexican Peso in Latam, close to the home, the Korean Won will come under pressure. In that scenario, the euro actually holds up pretty well. It is pretty well supported at around 1.30 level. If we are looking at currencies such as the rupee as well, then rupee will probably sell-off as a result. However, given that this is more of a US specific problem, I think the big exporters out of Asia will suffer rather, than the economies that are more domestically driven in the region, such as India and China.

Q: So, you do not expect too much of a downside for the rupee? In the first few weeks of January, do you expect risk will kind of curl back? What kind of losses are you expecting on the rupee? How would you look at the first quarter for the rupee?
A: In the first quarter for rupee, we are pretty positive. In the event that we have gone over the fiscal cliff, I think there is some modest upside risk to dollar-rupee. Once the cliff is resolved, then things will look much more positive. Then dollar-rupee can perhaps get to 53.50 on a three-month horizon. However, if you are looking for currencies that will sell-off in the region, it will be led by the Korean Won, which we look to come in at 11.05 in a month's time.

Q: So at its worst, you do not expect the rupee to go beyond 56? It is prevailing upside for the dollar is 57.
A: It is not that this is not going to be negative for market. I just think that we will not see an outsized response from the rupee, because this will be very much a US specific event. It will be those countries that are more levered to the US that will suffer.