Mkt to be under pressure in the absence of Fed action: Citi

Markets are closely watching the Federal Open Market Committee (FOMC) meet on Wednesday and John Woods, MD & Chief Investment Strategist at Citi Pvt. Bank said markets are likely to be under pressure if the Fed does not take any concrete action. He believes the global markets are pricing in German approval at this point in time and the conditionality on ECB's bond buying programme will be watched closely.

"It's the conditionalities that will be attached to the approval that we need to pay close attention to. I think the approval is pretty well priced in, but it’s whether or not these conditionalities delay the bond buying program and essentially upset Draghi's initiative to support Spanish and Italian yields," explained Woods.
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He also expects emerging market rallies to be sharp but, short in nature. According to him, strong domestic economies will attract more capital in the future.  Here is the edited transcript of the interview on CNBC-TV18. Q: First up the Federal Open Market Committee (FOMC) itself. So much is being pinned in terms of something coming as early as late Wednesday itself from the FOMC. Are you expecting that we will get a concrete bond buying plan from the FOMC late Wednesday?
A: I am not confident. There seems to have been a pretty extraordinary shift in market expectations following the jobs number we had on Friday and the market now has become almost unanimously round to some fairly aggressive action by the Fed in terms of USD 400-600 billion of mortgage backed securities for example, expanding the Fed balance sheet in quite an aggressive way.
I tend to still feel that there is some sense in keeping some powder dry ahead of the fiscal cliff in January. At a personal level I think I would be pretty surprised if they threw the kitchen sink at the US economy as it were at this juncture and to that extent perhaps the market is setting itself up for somewhat of a disappointment.
Obviously anything less than that's currently priced in would be seen possibly as a reason to sell into these recent highs we have been seeing. Q: Would you expect in that case the selloff to be sharp at all, because if the market is holding onto the hope that this is just getting postponed by perhaps three or four months to meet the fiscal cliff issue which will definitely come up then do the markets really selloff so much?
A: The markets had a good run YTD. Talking of the S&P we are at 14.5% or so. In my view, we are getting to somewhat stretched levels both in terms of a conviction in terms of valuations and frankly the turnover remains very, very poor. If we don't get what we expect from the Fed I suspect very much a downward pressure.
But obviously the recent run over the last year or so has been the expectation of further intervention and easing down the road which tends to build a floor underneath equities. I think we continue the same sort of rangebound action that we have seen over the last 18 months or so. Q: What you will be actually pricing in terms of what can happen in Europe? Do you think there can be some serious upsets from the Constitutional Court at all? We had German policymakers, notably Klaus Regling who administers the European Financial Stability Facility (EFSF) telling us that he doesn't quite expect the German Constitutional Court to throw up any negative surprise. But there have been fresh litigants saying that the ECB bond buying definitely is contrary to what the German Constitutional Rules agree to. Do you think we would get an upset at all?
A: I think it's the conditionalities that will be attached to the approval that we need to pay close attention to. I think the approval is pretty well priced in, but it's whether or not these conditionalities delay the bond buying program and essentially upset Draghi's initiative to support Spanish and Italian yields.
I have noticed for example in the last few days or so, those yields have been ticking up again in fear of these so called conditionalities. We will have to wait and see, but certainly there still seems to me quite a philosophical difference between what Draghi is seeking to achieve and what the Bundesbank is willing to concede.
Certainly the idea that simply purchasing unlimited amounts of Spanish or Italian bonds and parking that risk or migrating that risk to the balance sheet of the ECB is seen with somewhat of a raised eyebrow in Germany.
_PAGEBREAK_ Q: Actually the markets have priced in a lot, even in Europe for instance, the 10 year yield on the Spanish bond has fallen all the way from 7.4% something at one point in time all the way down to 5.7% today, that’s nearly 180 bps in terms of gain. Do you think they are stretched? Do you think incremental good news will be hard to come by as Spain struggles to ask for a bailout because of the conditionalities that will be attached?
A: I think the conditionalities are not going to be deal breakers, but I think they have the potential to delay the immediate implementation of Draghi’s program. The reason why as you point out yields have fallen so dramatically is clearly the market is replacing default risk as assigned to Italy and Spain from those lofty levels of 7.5% plus change, right down to where we are at the current level.
The risk of Spain being unwilling to fund itself or unable to fund itself at previous levels clearly is reflected in the scope and scale of the ECB proposal. But I think we just need to wait and see most importantly the extent to which Spain is willing, essentially to put up its hand and request a bailout package. We haven’t seen that yet.
Obviously the market is looking for that as the next material stage in the journey that is the eurozone crisis and once they have done that obviously, we can then start to see some substantive forms of intervention by the ECB assuming that it is signed off and get to the next station supporting those yields. Q: How would you approach emerging markets at this juncture? In the event that the Fed does not go with the expected QE3, would you see a big selloff in countries like India which have been very good performers up until now and in the event that indeed a QE3 is announced and some kind of unspecified bond buying is agreed to what kind of rallies would you see in a country like India?
A: If previous interventions have been anything to go by I think what we can say is the scale of appreciation and the duration of the rally will be less than previous initiatives. As I said there is sort of half life of diminishing returns at work here. So any rally that is triggered, I suspect, is going to be possibly sharp but also quite short.
For countries like India they have attracted a substantial amount of capital compared to other Asian countries for the course of this year and as you say the appreciation in equities has been pretty strong. I guess that’s more a function frankly of India’s composition as a domestic oriented economy rather than any material run up in equity sentiment.
The same could be said frankly across all of Southeast Asia, compared particularly to northeast Asia where trade dependent equity markets are getting unduly punished compared to those in the south. I think that’s the catalyst. It is those countries in south and southeast Asia whose markets are dominated by domestic demand. I think that’s the takeaway that I would want to communicate.
Where you have a reduced exposure to the volatilities and external risks of selling products to the eurozone or the United States, that really is impacting underlying growth, underlying profitability and I think that’s what is going to drive markets ultimately. Q: Taking into account all these factors therefore, from now up until perhaps the end of the year or early next year what would be the asset classes that you would think are the best bets?
A: Where we have seen most interest and indeed where total returns have been most exciting is frankly in the high yield and high grade bond market. High yield Asian bonds have returned around 13-14% YTD which is equivalent to or in many cases above that achieved in equity markets, but obviously on substantially lower volatility.
The investment grade spaces around about 8-9% with substantially lower volatility obviously and we suspect that the hunt for yields from developed markets will continue into the Asia region supporting total returns and for that reason we have been recommending clients in particular overweight those two sub-asset classes and focus on a generic basis at the credit space in Asia which we think has many, many quarters to run and will generate quite attractive returns to investors.