Markets still expect QE and lower rates from Fed: RBS

Michael Michaelides, European economist, RBS, says that the market is expecting a QE and extension of lower rates from the Fed. It is unfair to say that there are no event risks coming up in Europe. The Troika review in the upcoming Greek discussion around the Greek austerity measures on the potential extension that discussion is very much likely to come to the fore in next few weeks as the terms of that discussion heighten.

Below is the edited transcript of his interview to CNBC-TV18. Q: There is positive news by German Constitutional Court of not imposing any conditions and asset markets are in some profit booking mode. Do you see this rally continue at least in the near term now that most of the triggers have played out in the positive?
A: From the market point of view this is definitely positive news that the ESM has been ratified without conditions. It is clear from the judgment that the Constitutional Court is keen to ensure that the German maximum liability remains 190 billion.
This doesn’t have any immediate implications, but there is one possible future problem for the market that the ESM is trying at the banking license which is a much threated idea in Europe and that would not be possible as you need to immediately go back to the German Parliament to regain a proof for that measure. On a general basis, this is one of the risks that was present in the market and now it is off the table so it’s positive from that point of view. Q: Will the ghost of this judgment keep popping up here after? We know in terms of the total amount available with the ESM it is not going to be enough to bailout both Italy and Spain as well this unlimited bond buying the word which Draghi used is what has been propping markets, it is not quite unlimited going by the ESMs kitty. So in the future will this constrain, the help that either the ECB or the ESM can provide to markets?
A: With regard to the unlimited bond buying, the ESM treaty in itself doesn’t limit that what the country would need to do to apply to the ESM to get support in the primary market and that would provide cover and the conditionality for the ECB to even intervene in the secondary markets. With regards to whether or not the ECB program will work with the ESMs assistance, depends very much on whether or not the markets perceive it to be credible.
If the markets perceive it to be credible and the ESM only needs to support a small amount of the extra issuance of Spain or Italy whichever countries might come to the program, then the ECB program may work because then the ECB support bring down bond yields and contrary to remain access to the market.
On the other hand if the ECB is perceived even unlimited or at some point various members of the executive board or the governing council might want to pull away from this action than this might not work, as the ESM can only buy 50% of the bonds in the primary market, it can only support 50% of the new issuance coming out of these countries.
If markets don’t perceive to do well and not willing to take the remaining issues down then these counters may be forced into full bailout which is what the ECBs actions are designed to avoid. Q: Rahoy is still not very certain and maintains that he wants more clarity but we almost have most of the conditionality in, what else should he be waiting for in terms of more conditions before he can go and ask for it and do you see that happening more in October rather than September?
A: The reluctance from the Spanish side is not so much to accept the deficit target that already accepted quite harsh deficit targets from the European Commission, its more do with the specific measures. Spanish government says that they are happy to cut deficit this and next year to meet the goal of below 3% deficit in 2014. We don't want the ESM and the Troika to say which measures we should cut in particular. I think this decision is likely to get postponed, more a case when Spain will have to access ESM because of rising bond yields and more for market access rather than going for sooner or later. Q: Would it be fair to say now that immediately in the short-term there are no triggers to watch out for from Europe, the markets have reacted to what they had to from the Constitutional Court and now they will be reacting only to the FOMC? How do you see them preparing for the FOMC, are they over bought? Are they entering that decision with long positions expecting a QE?
A: The market is expecting a QE and extension of lower rates from the Fed. It is unfair to say that there are no event risks coming up in Europe. The Troika review in the upcoming Greek discussion around the Greek austerity measures on the potential extension that discussion is very much likely to come to the fore in next few weeks as the terms of that discussion heighten.