Bernanke likely to announce QE3: Citi

The US Federal Reserve will begin its two day policy meeting today. The Fed appears poised to launch a third round of large-scale asset purchases or quantitative easing 3. There are expectations that policymakers may also extend their low-interest-rate guidance into late 2015.

Geoffrey Dennis, managing director and Global EM Strategist, Citi is hopeful of FOMC cheering the markets with another round of QE this week since the recently announced US employment data was subdued. "The payroll employment numbers were very weak indeed last month. They show a lot of sign the economy is not really showing much strength in terms of the recovery. In particular, the labour participation ratio is the lowest it’s been for 30 years," he explianed. According to Dennis, the Fed would focus their attention on the Mortgage-Backed Securities (MBS) market. "They will probably establish a target for the whole of the QE period which will last until the middle of next year," he elaborated. So, he expects the markets to grind higher heading into the year-end. "All of this enormous central bank help is positive for risky assets. Therefore you get some upside in equities between now and the end of the year." Below is the edited transcript of Dennis’ interview with CNBC-TV18. Q: How have you read the recent data from the US and do you think it’s signalling that Ben Bernanke might announce a solid QE3 tomorrow? A: The data has been not so bad in fact in the US, it was a little bit better for a while. Then most recently the payroll employment numbers were very weak indeed last month. They show a lot of sign the economy is not really showing much strength in terms of the recovery. In particular, the labour participation ratio is the lowest it’s been for 30 years. We feel that they were weak enough of all the data that they do kind of qualify for an assumption along with what Fed Chairman Bernanke said that really the employment numbers are disappointing and so we fully expect to see the FOMC this week announcing another round of QE. Although there is a lot of uncertainty about what that type of QE will be, but we do expect some more action from the Federal Reserve as a result of the FOMC meeting this week. Q: Are such expectations priced in to a large extent? How much can it do for the stock market? A: We are in a situation where in kind of general terms if the US data is better that is good for the markets. If the US data is disappointing that's also good for the markets, because it leads to more action by the central banks. This particular round of QE is conceptually probably priced in. But, it depends on what they do. We feel they will focus their attention on the Mortgage-Backed Securities (MBS) market. They will probably establish a target for the whole of the QE period which probably will last until the middle of next year. It may depend on what is the actual details are as to how the market responds to that. Unless the US economy slides back into recession, which frankly we don't expect, we look for the US to continue to grow at around 2% rate. The fiscal cliff at the end of the year remains a hurdle which is a risk, but if the US continues to grow at 2% as opposed to sliding back into recession, all of this is good for equities over the long term. You either get better data and equities like that because it makes the investors feel better about earnings or you get worst data and then you get more action from the Federal Reserve. The real risk in the US would be in the event that the economy slid back into recession and we don't expect that. Overall, we think it means that markets basically grind higher gradually. QE2 is less effective for emerging markets than was QE1, but overall it still looks to us to make sense to be bullish about EM as a result of all the Central bank action. We also think investors should be somewhat aggressive in terms of their sectors because we think all of the central bank action is ultimately positive. Q: How much upside do you see for emerging markets then for the rest of the year? If indeed the good scenario plays out that today we don’t get any kind of obstacle from German Court and you get QE3 as expected tomorrow, how much upside can that spark off? A: Our current target assumes 13% up to the end of the year, so that might be a little bit aggressive. But, we certainly expect to see a decent move between now and the end of the year, 10-13% would seem quite reasonable. What has happened recently is that all the seasonal factors have really got messed up. We had some better months earlier in the year relative to the seasonals. Then concern was that August and September would be quite weak and they have turned out to be a little bit better than expected. We are fighting this kind of continuous wall of worry. August was decent. September so far is turning out to be reasonably good. Sluggish global growth, somewhat better emerging market growth and plenty of support form global central banks will probably move us higher over the rest of the year. But, it will probably be hard work. _PAGEBREAK_ Now as far as Europe is concerned, it is not clear we expect at the margin that the Constitutional Court in Germany will ratify the ESM tomorrow. But there is a risk that that doesn't happen and that gets delayed. Assuming that it does occur either tomorrow or eventually, assuming the results of the Dutch elections is favourable towards the Euro i.e. a new coalition is established which is pro-bailouts etc. and the new Outright Monetary Transaction Programme (OMT) from the ECB kicks in, again we think that will contribute eventually to higher markets. This is because some of the worst risks in Europe will be eliminated. Now the risk here is Greece. But overall, all of this enormous central bank help is positive for risky assets and therefore you get some upside in equities between now and the end of the year. Q: This has been driven by fairly significant flows into emerging markets and India has been big beneficiary. Do you expect that basic trend of benign and supportive liquidity to remain in place? A: It's very interesting because there is no doubt the flows have begun to return to emerging markets this year. We have had inflows into emerging market mutual funds of about USD 18 billion. That contrasts to a much more negative performance in terms of flows in terms of developed funds. You have seen this inflow of funds and yet you really haven’t seen any outperformance. We are underperforming developed markets by about 400-500 bps so far this year. We are up about 5.5%. Developed markets are up about 10%. It has not been reflected in relative performance. You are beginning to see a little bit more enthusiasm on emerging markets right now. Particularly, as investors see more easing coming from central banks, see more attractive valuations and are betting on and we have really not seen it yet, some sort of bottoming out of Chinese economy. The apparent dichotomy between good inflows into EM and poor relative performance is because we think a lot of global investors, not emerging market investors, have been reducing their weights in the emerging markets this year. We have seen development markets outperform. We have seen the US in particular being very strong indeed. We think that is beginning to reverse or at least there maybe signs that that is beginning to reverse once again. Q: You are constructive on emerging markets, but still underweight on India. Why is that? A: Yes that is right. We are still underweight. Our Indian strategy team under Aditya Narain has the target for the end of the year of 18,400, which is about 5-6% away from where we are today. We like the market; we just don't think it is going to be an outperformer. India has been an outperformer this year. It's up about 10%, so it's been an outperformer. That has partly occurred because of foreign inflows, but it also outperformed for a period of time over the summer when you started to see oil prices come down sharply and commodities generally, which obviously favours India, particularly a big importer of oil. From here, the story in India is similar to what it has been for a while which is that the market is cheaper than it was, but is still quite expensive compared to emerging markets overall. It's trading on just over 14 times 2012 compared to 11 times for emerging markets overall. You are getting a slightly better earnings story out of India. We think earnings growth will be 11-12% in dollars, whereas for the asset class as a whole it’s going to be more like 4%. To a certain extent, that would offset some of that higher valuation. What really gets India going is a little bit of a reduced premium versus emerging markets overall, some real sense that we are going to have another big pullback in commodity prices which frankly we are not expecting at this point in time. The other thing that gets investors going with India is when you can see a clear bottom in the economy, which maybe happening around this point. Investors also want to see a little bit more clarity in terms of the politics and in particular some sort of resumption of serious structural reform, which has been a big disappointment for many months now.