Prospects of the US Fed raising interest rates makes the bonds in that country attractive says Claudio Piron, Head of emerging Asia Foreign Exchange and Fixed Income Strategy, Bank of America.
In an interview with CNBC-TV18, Pirion says he expects the dollar index to strengthen further. The dollar index has already hit the psychological 100 mark and Pirion says it could climb another 3-4 percent.
Pirion sees the euro at 1.08 to 1.1 to the dollar by end of 2015, and he expects Asian equity markets to be robust.
On India, Prion says he expects the rupee to be stable and trade in a range of 62-64 to the dollar.
Below is the transcript of VD Claudio Piron's interview with Latha Venkatesh & Sonia Shenoy.
Latha: Explain this to us, this strength in the US dollar; should it be seen as negative for risk assets, equity assets in the US at all or like in 2003, it will not affect US equities?
A: I think clearly we are seeing signs where the strength of the dollar more recently has started to dent the performance of the Standard and Poor (S&P) 500, remember about 40 percent at least of the S&P 500 derives its earnings from overseas. So, clearly the strength of the dollar will impact negatively those earnings. Therefore, in terms of negative risk factor, unless the strength of the dollar is concomitant with strong US economic data, then there will be an impact on corporate earnings. Fortunately enough, last week we had strong non farm payrolls data which seems to suggest there is still an ongoing economic recovery to the US. It suggests that maybe there will be some offset to the weaker earnings due to the foreign exchange (Fx) translation. But that also diverges from what we are seeing in the rest of Asia. In Asia, what we are seeing is a very negative divergence in terms of negative Fx performance in Asia, but strong equity markets or at least robust equity markets coming forward.
Sonia: That is an interesting point you make about 40 percent of S&P 500's earnings being derived from the dollar. If so, what is the sense you are getting about the levels on the dollar index itself because we have been hearing from a lot of experts that there is aggressive buying of the dollar ahead of the Federal Open Market Committee (FOMC) policy on the 17th. Is that what you are observing as well and what could the near term upside for the dollar index look like?
A: I think there is an important point to distinguish here. We look at the dollar index, but it is an index. It is purely a nominal value and that goes the same for euro dollar. It is also important to look at the dollar in terms of trade weighted and inflation adjusted terms. And, while you pointed out previously that the nominal DXY - dollar index is back to 2003 highs, on a real effective inflation adjusted trade weighted basis we are not there yet. So, clearly this dollar can strengthen further because it does not necessarily mean we have started to hit the export competitiveness of the US. And I think there are two key points that underpin the strength of the dollar. The first as you say is the prospect of the Federal Reserve system raising interest rates which will make potential US bonds more attractive in yield terms relative to international markets in Group of 7 (G7) world and second, we had a weak dollar for over 12 years now and within that time the US economy has become far more competitive, particularly in terms of shale oil, gas, energy production, etc. So, I think the dollar here has further upsides, significant upsides as we go on a multiyear bull trend.
Latha: Now to come to the ingredients of the dollar index, the euro dollar, which is the big one? Where do you see that range? Even that is tending towards its 2003 levels. So are you looking at Euro parity and what will it mean that for asset losses?
A: Our current forecasts stands around 1.10-1.08 yearend and clearly I think what has happened is that despite us being dollar bulls, the market has somewhat moved ahead, but it is plaintive for everybody to see that the risks are towards parity particularly as the European Central Bank (ECB) is embarking upon a quantitative easing programme, which is by some dimensions even larger than the US when you look at the outright purchases by the European Central Bank; it amounts to something like 60 percent of the gross issuance this year of bonds by the euro zone. And, in effect, what we think that will mean is as bonds yields continue to go to zero and in fact in many cases turn negative that will push many foreign investors out of the euro zone and into other alternative bonds outside of the euro zone. And that will again accelerate and add to the pressure on the euro as foreign investors turn away from European bond markets unless those yields compress and move lower.
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Sonia: Apart from tracking the forex market closely, you also track a lot of flows into several markets whether it is equities or bonds. Given that we have a slowdown that is currently underway in markets like China, and now there is talk of a slowdown in earnings for some of theses companies that derive their earnings from the dollar, what kind of flows do you expect to see into emerging markets like India? Do you think with no other place to put money into, perhaps we could see higher flows into Indian equities as well as bonds?
A: Yes, absolutely. And I think that continues to be the case. Almost every client I speak to internationally is pretty much bullish on India. I think the difficulty that they face within India's domestic government bond market is limited access to that market. And that is spilled over, obviously, into the Indian corporate bond market. But again, there are limitations there, given that some mandates by international investors are contingent upon having an international credit rating for some of the corporate debt. So nonetheless, given what you have in India is quite unique although less unique now in the past couple of weeks, but what you have in India is a well-telescoped Reserve Bank of India (RBI) easing cycle and that easing cycle by the RBI naturally equates to asset inflation. It is good for bonds, it is good for equities and it looks to be a one year, two year RBI cycle. So, that kind of clarity gives foreign investors quite a degree of comfort in terms of investing. And if you overlay that against the reform programme by Narendra Modi, then I think again, it looks as if this flow will continue. At the same time the Reserve Bank of India is in no mood to allow the currency to appreciate too far, too fast. So, in effect, what you have is a stable exchange rate for India, but again a buoyant background in terms of foreign investments into bonds and equities.
Latha: So, is there any range that you have for the rupee?
A: 62-64/USD
Latha: What is your sense about the dollar yen? Are we going to see any more weakness in the yen or strength in the dollar and will that also add to the dollar index strength?
A: Yes, our expectation is that in particular, in Asia, we will see broad based dollar strength. What is notable across Asia is what you see is that Asian equity performance is positive, but the Fx performance is negative. Again, bonds are performing positively across Asia but the Fx is performing negative and this is pretty much unheard of. Typically what happens is Asia is what is good for bonds is good for Fx, what is good for equities is good for Asian currencies. However, the implication here is that to a certain extent Asian central banks are engaging in a currency war. They are in effect preventing the appreciation of their currencies buying dollars in an effect to prevent the inflows from resulting appreciation and I think that will again reinforce the strength of the dollar as part of a global phenomenon.
Sonia: Do you have any assessment of what the dollar index could rise to say by the end of 2015 or even in the next six months?
A: Clearly in a certain sense we could rally by another 3-4 percent. I think that is certainly the implications of the terms of the momentum we have in the market and I would say that is in a sense also a conservative projection.
Latha: And that will necessarily mean parity on euro dollar?
A: That is a possible implication. Again, I am restricted by what we officially have as our official forecasts.
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