BoJ policy may create favourable backdrop for EM flows: Pros

The Bank of Japan Thursday jolting global markets by keeping its interest rates and its quantitative easing levels unchanged. The US Federal Reserve too kept its policy unchanged leading to turbulence in global equity and currency markets.The yen by mid-afternoon had hit a 10-day high of 108.25 and the euro rerated more than 2 percent and short yen positions got washed out.To discussing the impact of this decision on the equity and currency markets, CNBC-TV18 spoke to Ananth Narayan, Head - Financial Markets, Standard Chartered Bank, Arvind Sanger, Founder and Managing Partner, Geosphere Capital and Christopher Palmer, Founder and Chief Investment Officer, Benson Avenue Capital. The channel also spoke to Manish Singh, Chief Strategist & Head of Investments, Crossbridge Capital LLP.Sanger believes, we are reaching a point where central bankers are in no mood to fix all the problems. According to him, BoJ has recognised the fact that there move of going into negative interest rates has not brought the desired results and maybe they want the government to move on the fiscal policy front. Meanwhile, with the Fed too staying put and not hiking rates, one should expect global volatility going forward, says Sanger.Sanger believes that with growth remaining challenged in developed markets and central banks staying put, it would create a favourable backdrop for EM fund flows. Agreeing with Sanger that the central bankers cannot fix all the problems, Narayan says in fact the BoJ decision might not be a bad one because the ICU-kind of treatment by the central banks cannot work for ever.Strengthening of yen was an obvious reaction of BoJ’s decision, he adds. Going forward he expects dollar to strengthen against the yen.He says the positioning in the dollar-yen trade is very large and could take some time for that to unwind. The current levels of 108 on the yen are good support levels and if they break one could see a rapid downside on yen. Palmer also agrees with Narayan that the large positions in the dollar-yen trade would take several weeks to unwind. However, he does not see this impacting the flows into emerging markets because a weaker dollar has always been good for EMs fund flows. According to Sing the BoJ policy impact could be behind us in a few days and going forward he expects Japanese Central Bank to ease in the July policy.Talking on the US Q1 GDP data which came in at 0.5 percent which could mean a full year GDP growth of 2 to 2.5 percent, he says the number should not be seen as a bad number.He too believes that as long as dollar doesn’t strengthen EMs will see capital inflows.Below is the verbatim transcript of panel discussion with Surabhi Upadhyay and Latha Venkatesh on CNBC-TV18. Surabhi: What did you make of the fact that Bank of Japan (BoJ) wasn’t willing to play ball, what we have seen today in the currency is that a 1 day event and life will perhaps go back to a little bit of the normal from tomorrow or is this going to have a far reaching consequences? Sanger: Well, my view for the last few months has been that we are reaching towards the end of the last three years of the Central Bankers pulling all the levers and fixing everything in the world and BoJ frankly probably recognising that their move into negative interest rates a few months ago has not delivered anything meaningful yet and therefore they are probably looking for little bit more from Prime Minister Abe and from the government’s side in terms of fiscal policy and doing more negative rates is not necessarily proving to be something that is uncontroversially working. Therefore I think that we are in this situation where the ramification of this will be no over time, but there are real questions about whether negative interest rates have the desired effect and BoJ’s stand in fact may be indicative of the fact that they are trying to evaluate where they go from here and were the more negative rates are. We are certain that definitely has consequences for how the European Central Bank (ECB) goes in the future in terms of doing more, the Federal Reserve (Fed) obviously in a different ball game completely where they are trying to figure out the timing of raising interest rates, so it creates a lot more global volatility and days of counting on central banks to fix all problems are behind us, so we are going to just to have get use to this volatility. Latha: This is exactly the dichotomy that we want answered. Is this just a 1 day wonder or a 1 day disaster or is it that this is telling you that the emperor has no clothes, that Central Banks are not going to be able to fix so many problems and therefore this is the start of a bigger unravelling? Narayan: Look, this one immediately looks like an immediate reaction to the fact that the BoJ disappointed. Clearly, given the growing strength in the Yen over the last few weeks and given the fact that we just had an earthquake in Japan and that the economic data in Japan was pretty soft over the last few weeks again, there was a building expectation that BoJ would come up with another big bang effort to try and rev up the market and try and weaken the Yen from where it is. Now of course, when the BoJ disappointed, I guess the markets have reacted and we have seen that violent reaction in all Yen process. In a funny way, though frankly this might not be a bad thing, the fact that the BoJ has stood pat. Over a period of time, there is this monetary policy, ICU-kind of treatment which has going through for Japanese assets and it always a question mark as to how long this is going to work. I guess because of this expectation that BoJ will eventually weaken the Yen and foreign currency asset will strengthen against the Yen. A lot of things have been built up over time, so you had Japanese investors investing in overseas assets, you had Japanese exports stopping to hedge and globally speculative positions have been built up on long foreign currencies against Yen. Now the problem with all these positions being built up which took dollar-yen all the way up to 125 at one point of time is that given the underlying fact that you have a current account surplus in Japan you will have, inflows of foreign currency coming through and when the market start to retrace a little bit then everybody tends to panic, which is what is happening right now. Now yes, If BoJ had played its role and delivered a strong monetary action the markets would have cheered that, but we still aren’t out of the morass as yet, where everybody seems to have gone on one side betting against the Yen. Now in a sense taking out this kind of lever allows the market to may be settled down a little bit and then allows fundamentals to take over and as your previous speaker just mentioned there is a fundamental in play which is that the US is in a far better shape than Japan is and eventually it’s fair to assume therefore the US dollar will strengthen against the Yen. Sure it’s an interesting segue in the US markets which is in a very, very different space from Japan and we also have the Federal Open Market Committee (FOMC) coming out overnight. Look the reality is the US is in a tough spot. We had this extraordinary monetary easing policy in the US, 2008 was it when it went to down to zero percent rates. In 2009 early we had S&P at 700 today it’s at 2,100. You had real estate prices looking really, really soft in 2009, it’s now recovered quite sharply from there. Consumer Price Index (CPI) was 0.6 percent in early 2009, it’s now 2.3 percent. Clearly the markets have recovered from those absolutely abysmal ICU type conditions, yet we have just had one rate hike since then to a paltry 0.25 percent. This doesn’t look like a situation which warrants extraordinary monetary policy conditions and I am sure the US would loves to see some amount of normalcy brought back into the monetary system. Nobody suggesting that the economy is running away anywhere. Clearly, we are not talking about rapid rate hikes, but to have extraordinarily low interest rates even now at a time when unemployment is now down to 5 percent from the highs of 10 percent. It just doesn’t sound right. Yet, it can’t do that because if China was to wobble again tomorrow and given the fact that confidence is so low right now you really don’t know how things will pan out. Latha: I completely take your point that Central Banks don’t have much elbow room at all at this juncture, but just to get to the immediate problem after all the Yen was at 108 in early April probably April first week, so is it just that we are going to see some shifting of positions because people would have gone short Yen and they are just going back long Yen. Is it only that much or is it a major unravelling of carry trade, that a lot of carry trades happened in the Yen and much more will have to unravel? Narayan: I think the underlying positioning is quite large and unfortunately we will have to discover how much of the unravelling will happen as time passes on, but I think in a vicarious way it’s a good thing that the BoJ has disappointed today. It allows the positions to settle and hopefully find a bottom for dollar-yen allowing things to settle down and move up again. Now, as I said, if we had BoJ actually delivering as per the market expectation, we could have a pop-up in a Dollar-Yen in the short run, but the eventual positioning again would have caused pain all over again and markets have the funny way of moving in the direction of pain, so in a way it’s good that we have catharsis. Hopefully dollar-yen doesn’t go around too much further as I said the fundamentals still warrant an eventual weakening of the Yen. This positioning hopefully will get resettled into stronger hands and then may be a bottom of 105 or so and then from there we move on back again to a better trajectory for the world as a whole. Latha: The wobble for what it is worth has made the Indian markets cheaper by 2 percent. It has made several other markets as well cheaper by between 1.5-2 percent. Would you treat this dip as a reason to buy? Sanger: I would not get too excited about a one day dip creating an opportunity. I think volatility is going to be around with us this year. One has to be disciplined and find opportunities as they come along and the global macro will create opportunities in India. I do believe that one of the things to keep in mind is BoJ went to negative interest rates in January. Since then the Yen had already strengthened by 10 percent. So, somehow the idea that the last time negative interest rates didn’t work and this time if they did it, it was magically going to work - the markets are kind of looking for things which have stopped working. Oil is going up, so the deflation fears are receding. However the growth rate around the world and the US rate is weak. So, you have a lot of cross currents. European growth is weak, Japanese growth is weak, US growth is weak although it is the tallest midget in the current environment. US also seasonally should recover in second quarter in terms of its growth rate. So, all of these things are playing in the backdrop. India has a position where some of the underlying economic data whether it is power demand which was double digit levels in the first quarter or it was oil demand in the first quarter which was 12-13 percent or it has been cement demand in the first quarter which is now touching double digit levels. So, there are underlying signs of real strength. Again I don\\'t pay attention to the GDP stats but there are signs of strength. So, I would look for volatility as my friend but be patient in individual names to buy because I think the Indian fundamentals are finally turning. While the quarter itself has not been so far anything to write home about but it hasn’t been a disaster either. I think the underlying trend suggests that things are heading in the right direction. Latha: We were just discussing about the impact of the disappointment from the BoJ. Do you expect it to be only for a day or two or do you think the Yen carry effect and the unravelling can go on for may be several weeks? Palmer: Well, positioning of investors on the Yen carry is quite large and it could several weeks for players across the board, funds, banks and corporations to unwind a series of trades which they had hoped would point to a weaker Yen, because of quantitative easing (QE) in Japan, but also the prospect of negative rates. Now that on hold the investors are going to step back and possibly unwind those trades which our understanding is are in fact very large. Latha: So would they result in outflows from emerging markets (EM) we have only recently seeing EMs getting funds, would that also mean that EM equities would see outflows. Palmer: No, in the case of emerging markets, we always maintained that a weaker Dollar is in fact, usually good for emerging markets. It’s in fact a sort of back to easing which is why it’s real interest rates for emerging markets and that’s sets an easier tone for monetary policy in the emerging markets and we should see a relatively good reaction from EM currencies versus the US Dollars and where the currencies lead, we believe the emerging markets will follow, so this could be setting up for in unexpected follow-on rally in emerging markets, given just how weak the US Dollar has become on the back of this. Surabhi: We heard your earlier bullish view on India but what about the flows picture because it is the flows that has lifted us up to almost 8000. Given how different central bank policy is poised right now, the US on one hand then there is the BoJ, what is the next move in terms of fund flows you think particularly fund coming to emerging markets? Sanger: Emerging markets have benefitted from many things this year. Obviously the Fed going dovish has helped, the ECB and the BoJ going dovish earlier was not helping but after the went dovish it has helped. I think the recovery in commodity markets has also coincided with the rally in many emerging markets. So, the best performing emerging markets this year are markets that are commodity oriented economies. So, I think there is a multiplicity of factors at play here which are driving the emerging market resurgence and capital flowing in that direction. I think if growth continues to remain challenged in developed markets and currencies are not going anywhere because central bankers are on hold and I do believe that the Fed is unlikely to go in June then I think it does create a very favourable backdrop for emerging market fund flows. So, I do agree with that. Latha: What would you say is the range for the Yen now? Does it get as strong as 105? Narayan: The positioning in the dollar yen trade is large. We will have to figure out how long it takes to unravel. We could see a dip - 108 the current levels are pretty strong support levels. If they break we could see a rapid down move as well. Having said that in the medium to long term I think the underlying fundamentals ought to take over at some stage. It is very difficult to call the bottom. Eventually we should see a return given the dichotomy in the US versus the Japanese economies and monetary policies, we should see a return to strengthening of the dollar. For Manish Singh's entire interview, watch video