$75-80 right crude price; more selling in Indian mkt: Pros

Jim O'Neill, formerly chairman of Goldman Sachs Asset Management Company, believes the right price for crude is USD 75-80.

But the long crude has resulted in short India. O’Neill sees more selling of Indian equities. According to him, to really get the Indian market rallying again, Prime Minister Narendra Modi and his team have got to deliver more specific things on some of the big reform challenges such as the much talked about - independence for the monetary policy council. “A true Bank of England styled monetary policy council - that would be something to get me freshly excited about the Indian market,” he told CNBC-TV18.

In terms of the dollar, the dynamism of the US economy will exceed its counterparts and thinking of currency as relative price, then more upward pressure will be seen given the ability of the US to raise rates at a pace that none of its peers can match will definitely put pressure on global yields, and also on the US dollar, is the view coming in from Manoj Pradhan, Global Economist Morgan Stanley.

Below is the verbatim transcript of Jim O’Neill & Manoj Pradhan's interview with CNBC-TV18's Latha Venkatesh

Q: I remember you saying last time that you are loath to guess crude prices but that is going to be my first question. Crude prices have recovered about 40 percent from their December lows, has crude overshot on the upside, does it fall or do you think it is going to remain at current levels or even be higher?

O’Neill: We might have some more to go. Even though I always like to emphasize in my discussions with you I am not obviously as professionally engaged in some of these things as I was for 30 years and trying to predict oil prices is sort of in the lunatic asylum area but I wrote something before December saying that I thought oil prices would end 2015 higher than they ended 2014 and I still think the big story is that we overshot too much on the downside. Not that oil prices will ever stay at the same price for very long at all but I think the equilibrium price given the current state of world economic growth and supply is somewhere close to where we are, may be a little bit higher than this. So, I think the recovery we have seen is really a response to a too big a decline for the fundamentals that took place.

Q: So, you think crude may average around USD 75-80 for the remaining part of 2015?

O’Neill: I thought about five years ago when oil was at USD 120 that the right price is about USD 75-80. I have no reason for changing that view. I think it suits many people around the world for oil prices to not be too high but also it suits many people, particularly the United States for them to be not too low. If I had to stick my head out as to the right price I think it is about USD 75-80. Whether that means that is where we trade is another matter.

Q: The long crude trade has meant short India. However even after this 10 percent cut in the Nifty from its March highs we understand that many fund managers are still about 400-500 basis points overweight India compared to benchmark indices. So, should Indian investors brace for more selling of Indian shares?

O’Neill: There could be more selling. I think about it as a personal investor as well as an analyst, I increased my personal exposure to Indian equities about 18 months ago just as we were starting the campaign for the elections. About 5 weeks ago after the Indian Budget I sold my position because I thought the oil issue was going to be less friendly and in addition after the Budget I am not sure what new good policy news in the near future could happen. So, I think the Indian market has had a fantastic run, it has priced now for a better Indian economy and for better earnings and I can’t really see any upside for the near future.

Q: The other trade that has reversed lately is the long dollar short euro trade. As well the German Bund yields that were falling suddenly shot up. How should we interpret all this? Does euro not fall back to that nearly parity level with the dollar? The Bund yields are they telling us that deflation is over in Europe?

O’Neill: To me the euro-dollar relationship correction was even more obvious. Obviously as many of your viewers probably know I have spent so much of my career in the foreign exchange market and one of the few lessons I learnt is that you never want to be with lazy consensus. In the first quarter of this year the widespread shared view that the US was going to grow very strongly, Europe had persistent problems and the dollar could go forever against the euro was almost ridiculous. It was very vulnerable to the US disappointing such high expectations and Europe positively surprising such low expectations and that is exactly what we have got. Let me also add importantly, I don’t think for me US perspective is sensible to allow such a big rise in the dollar because it is not good for the United States rebalancing post 2008-2009 crisis.

Now we have a more sensible market and my own view is we could spend quite a bit of time between 1.05 and may be 1.16-1.17 until we know a lot more evidences to what is really going on with the US economy and whether this weakness is temporary and more and more interest and relevance of the Bund story is to whether in fact Europe is now truly coming out of this fear of being like Japan. One of the ongoing most striking interesting things in the world is the strength of peripheral economy activity. Just this morning in Europe we have had much better than expected Spanish and Italian industrial production numbers again and I think the markets are too negative about the European economic situation where the crisis countries other than Greece are showing more and more signs of having shown some benefits from reforms. It reminds me of another one of the things I have learnt in my career is not a lot of crisis go to waste. It looks like these countries have made some positive adjustments.

Q: If Europe is growing and given some improvement in some emerging markets, can we say commodities have bottomed? Will they crawl up for the remaining part of this year?

O’Neill: I wouldn’t be surprised, I think we discussed oil earlier where it is clearer to me. For other commodities I don’t have such a strong view but I wouldn’t be surprised if they recover a bit further. We have had a very powerful move down now for about three years and these kind of corrections go on. What I would say is I do not believe that this is the beginning of a large multi-year rally in commodity prices. I do not think that that is the case.

Q: What would be your top three picks across equity markets indeed across asset classes?

O’Neill: Locally I have no professional obligation to make such predictions. I would say that my number one favourite remains Chinese equities as it has been all year. I think investors and analysts are underestimating the scale of China’s shift in terms of its own rebalancing and it is very good for consumer related stocks in China, particularly consumer stocks itself but healthcare, things to do with education and an improving Japanese society. So, I remain very bullish on that. I think what we have seen there this week is just really a correction after this huge rise but I am still bullish on Chinese equities. I think after the move we have had in German Bunds and the euro, at this level I think I would also have probably my second favourite European equities because I don’t think the euro is going to have a huge rise from here. As I said it could go to 1.15-1.17 but I don’t think any more than that. I think the ECB will keep its monetary policy friendly. So, I think the European equities outlook is pretty friendly too.

They are currently only the two big views I would have. So, I can’t really give you five. If I have to give you a third I would say it seems to me if we are seeing this story in Europe and the correction away from this fear of Europe going down the path of Japan, I have a suspicion that the Swiss Franc, as soon as we settle the Greek situation which at some point we will, I have a suspicion that the Swiss Franc could decline sharply because some of the broader reasons why the Swiss Franc has been so strong are quickly disappearing.

Q: Coming back to India, the markets have fallen about 10 percent and valuations have dipped may be from 17 times to about 15 times. Do Indian equities fall more or will they just meander at current levels?

O’Neill: At this level I would be a bit more inclined to the meandering part of your scenario. It is not impossible that Indian equities could decline another 10-15 percent given the amount of money that has gone there and if all the external factors were negative at the same time but that is not my central guess. My best guess is that we probably do meander around.

I was in India about the same time as the Budget, I also when I came back to Europe spoke at a very important retail investor conference about the long-term outlook for emerging equities and somebody showed me a chart of the long term returns for the 13.5 years and the scale of India’s outperformance relative to Brazil is so big that it made me think that may be the true long term investor might want to start thinking about going the other way. To put it in another way and to really get the Indian market rallying again I think Modi and his team have got to deliver more specific things on some of the big reform challenges. I am sure at some stage they will. What I would love to personally see in particular is these comments they have made about more independence for the monetary policy council. If they were to go ahead and implement a true Bank of England styled monetary policy council that would be something to get me freshly excited about the Indian market but without something like that it has sort of seen its game run out for now in my view.

Q: The manner in which crude prices have risen, are you getting a sense that some where demand is picking up and we should factor in greater demand for commodities for the rest of 2015?

Pradhan: It is hard to make that argument very convincingly. What we are beginning to see is two very different sides of the global central bank response. What you have seen quite strongly in the second half of last year and even earlier this year is that developed market central banks were aggressively as you would call it ahead of the curve. They eased in a way that monetary policy stances overall were easier, they did support growth and in fact particularly in Japan and in the euro area you did see that monetary policy was being eased at a time when growth had already started picking up. So, it was pro-cyclical. So, in a sense you are beginning to see the early stages of that happening in the euro area, whether that is enough to drive up overall demand for oil in such a dramatic way is different because when you look at who the real consumers of energy and metals and minerals are, it is on the emerging market side. Over there what we have seen is that central banks have cut but they have not eased monetary policy in the sense that real rates have actually gone up despite the rate cuts. Will there be better demand? Yes the US economies Q1 growth will disappear but Q2 doesn’t look fantastic. Overall our FX strategists may have made a point that sounds very pinion to me is that the dollars weakness may have had something little bit more to do with the oil price. Metals have not responded in quite the same way oil has.

Q: Would your base case be that crude has overshot and might recede a bit, how should someone making policies based on crude factor in crude price for the rest of the year?

Pradhan: I am not really sure that is probably the base case from our strategist point of view and certainly not looking at the fundamentals the US economy is on much surer footing. Its central bank is closer than anyone else in the major economies to have rate hikes. Certainly the euro area and the Bank of Japan the flows that have been coming into the US from our strategy colleagues also suggest that there is a lot more support for assets over there. I think overall what is happening over here is that the growth weakness in the early part of the year in the US economy and by contrast the pickup in growth in the euro area may have had something to do with these dynamics.

Again asset prices will depend on a huge number of other considerations and on bond yields I do think over there, there is some kind of backdrop of economic improvement in the euro area. Remember we are starting from an incredibly low level. Last year if you looked at the euro area the three prevalent themes were a very weak growth, risk of deflation coming up again and the prospect of monetary easing all of them had depressed global yields and in fact over odd any of the developments that were happening with very strong US data last year. So, it is not surprising to some extent that as euro area growth picks up you are seeing that downward pressure on global yields being released and yields moving upwards. Some of that is fundamentals but there has been a lot of concern on Morgan Stanley’s side and even among clients that these are incredibly illiquid markets. It is one of the ironic consequences of quantitative easing with the amount of purchases central banks are making, there isn’t as much liquidity even though in theory the money supplies are burgeoning with the cash that central banks have put out. 

Q: So, how should global economies, markets like India look at he US dollar, are we going t o see a resurgence of the dollar index, it almost came to 100 and then went back to 93. what should one prepare for for the rest of the year in terms of the dollar?

Pradhan: These kind of moves whether it is economic growth or asset price moves are hardly linear. If you look at the fundamental picture I think the fundamental picture certainly suggests that the dynamism of the US economy will exceed its counterparts. If you think of the currency as a relative price then you are certainly going to see more upward pressure given the ability of the US to increase rates at a pace that almost none of its other peers can match and that should put upward pressure on global yields. However on the US dollar will the pace be as aggressive? Possibly not because if you look at what we call the dollar tantrum, it had two elements to it, the first part was strong growth in the US and the second part was euro area weakness. That second part may not be as strong now.

Q: Let me come to India, I know it is not your special area of interest, it is one of your areas of interest but do you think that fiscal deficit numbers, inflation numbers are all slightly under threat because they were all made under assumptions that crude would be sub USD 50 or around USD 50. How do you look at the inflation trajectory, how do you look at rate cuts hereon in India?

Pradhan: There are risks whenever you take assumptions about any asset prices remaining stable. Oil is incredibly important to the likes of India, to the likes of Turkey. So, you have to make some assumptions about it and so there is a chance that you are going to get an overshoot, undershoot of oil prices, they will factor that in. A lot of governments also indulge now in hedges against these instruments. For example if you look at the Mexicans, the Mexican government has hedged almost entirely its 2015 numbers as far as oil is concerned. So, the upside and the downside risks over there don’t hurt them that much. That having being said I would say that the most important trajectory from the inflation and the growth point of view would still be on better fiscal management besides oil and better monetary management that is already underway, the real rates are actually quite high now and they have been creating in fact downside risk to growth. So, at the level where inflation is and given what monetary policy is doing I am not sure this is a time to worry about inflation.

Q: What about the growth story, where do you see growth delta around the world, would India be one of them?

Pradhan: It depends on the trajectory you look at. I know it is an economist answer but I am just focused on the next five years of growth in India and from that point of view it is very difficult to find a story that has the quality and the delta of growth or the gradient of growth that India has. I am not a buyer at all of strong Indian growth in the near term. I would not like to see a credit cycle in India that is rapidly generating into 7 and 8 percent growth because those are hallmarks of an economy that overheats and then falls flat, you don’t want that. In fact it is a blessing in disguise that the credit system is still impaired with the NPLs that are in there, so that you don’t have a lending boom on the back of this euphoria. Projects get a little bit better selected, real interest rates remain high and so the threshold for good firms to come in is the right one and that elongates the growth story. Those looking for a very sharp rebound in growth are very right to be disappointed right now but if you are looking on a 5 year trajectory I am very comfortable with what we are seeing in India right now.