Eye on Europe; mkts to be cautious: CCAM

As Europe moves closer to forming a banking union on Wednesday and the German Constitutional Court gives its verdict on the legality of the 500 billion euro rescue fund, ESM, markets are eagerly awaiting the developments. Mark Konyn of CCAM told CNBC-TV18, the market momentum has built over the announcements made by the ECB last week. However, before the big decision on the banking union comes out, markets are likely to be cautious.

Also read: Europe to outline banking union to tackle crisis

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Here is the edited transcript of the interview on CNBC-TV18.

Q: What's the market expectation in terms of the European events which are lined up?

A: Certainly the momentum has been building on the back of the actions taken and announced last week by the ECB. I think markets are quietly confident that the German challenge will be sorted and that ECB can go ahead and implement its policy. But, obviously before that decision there will be just an element of caution in terms of the way markets trade.

Q: The German Court ruling of course is what we are all eagerly waiting for. But whatever the EU President Barroso says about the banking union would largely leave the markets unruffled you think? It would be a matter of conversation and discussion between the EU sovereigns, but not so much market moving?

A: All the comments that are likely to be coming now and the issues facing the eurozone, as we move through the final phases of this year, will be moderated to try and not disturb the market. We are not expecting any disruption as a result of comments around banking union.

The groundwork has pretty much been put in place and there has already been some high level insignificant agreement on that front. It's more a question now of whether or not the ECB is able to actually implement what it has pledged to do, because as we know it's on a case by case basis.

Although, the intervention levels are unlimited in their own words, it does depend on individual countries meeting certain budgetary stipulations and requirements. They are negotiating on a case by case basis. So that as yet is untested.

Q: Everyone is expecting quantitative easing from the FOMC by Thursday evening, how do you think the markets will react in case the Fed doesn't give as broad a hint about quantitative easing or does not give a timeline or an amount, would you see a major selloff? If indeed there is reasonable clarity on when it will start, its expanded bond purchases, do you see an extension to the rally?

A: They have got a number of leaders that they can play with. But, the market has moved quite quickly towards an expectation of seeing the asset purchase program continue. I think any disappointment on that front would cause markets to pullback somewhat. Particularly in the context of the US, the earnings outlook is now looking a little bit weaker because we have seen companies do pretty well on the bottom-line, but the top-line has not been growing.

What we have seen is companies through the course of this year focusing on cutting cost to maintain the bottom-line. So any disappointment around the extension of that asset purchase program is likely to reflect negatively on the market. Certainly, we are in the camp which expects to see further action by the Fed.

We saw Ben Bernanke go to great lengths to give chapter and verse on the history of intervention through quantitative easing or through purchasing bonds in the market and trying to lay the foundation and state the case quite firmly that it has had a very positive impact on the overall economy. It has certainly had a positive impact on the financial system.

While that maybe the case, it may not be necessarily causal. There maybe some coincidence in the way things have worked out since they have begun quantitative easing and we would question whether or not another round of quantitative easing will have a necessarily positive impact on the economy.

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Q: Many people on the street believe that today the German Constitutional Court will give its go ahead, but there will be a few riders. Some say that that might limit Germany's contribution to the entire fund or Bundestag would have some veto power over ESM's operations? How will that be read by the markets?

A: I think we are not going to get an unconditional outcome here whereby there is a green light to go ahead. Remember, this is a challenge to the proposed activity of the ECB, whether or not it's consistent with the original charter. Even if the challenge is not successful, it doesn't necessarily guarantee that we are not going to see further challenges.

By judging overall public opinion in Germany, there is a ground swell of need for some control so that we don't see power or the decision move away from the German leadership. I think the market is expecting this to be basically a neutral or positive outcome in terms of the challenge.

But I don't think the market is expecting this to be set now for plain, easy sailing. I think the expectation is that it is going to continue to ramble on for sometime and that will plague markets a little bit as there is always the prospect of further challenges ahead.

Q: You made almost a cast iron case that Bernanke after building up the case of success of past interventions is unlikely to disappoint. Given that the QE comes what's your sense in terms of which asset classes in the emerging markets could move? Do you see generally the emerging market index higher over the next 2-3 months? Which markets would you pick?

A: We have already had some good momentum building on the expectation that we are going to get intervention out of the US. Forthcoming stimulus in China is yet to emerge and with other central banks following suit, clearly the issue around the ECB is a reason to be more risk on than risk off. So that trade is likely to continue.

Momentum is still out there, however that is cautioned with a degree of flight to quality. I think you have commented earlier in terms of the weakness in the dollar or the strength relative in the euro. That's likely to continue, a flow out of the dollar into other currencies. That is likely to continue as a result, not least from Moody’s potential downgrade that we saw announced in the last 24 hours.

But in terms of a risk on trade, emerging markets are likely to benefit from that. We have seen investors pullback very significantly since the end of the first quarter. India is clearly in line with that realignment out of emerging markets. India has done well as money started to flow back into the asset class. It has largely been on the back of ETFs as we have seen for all emerging equity markets and the momentum is there which will continue.

Short-term these days is probably something like 3-6 weeks rather than the 2-3 months that you have suggested in your question. Beyond that I think other issues will come into play, not least the build-up to the US election.