Fed in no position to pull plug on QE yet: Blackhorse AMC

He expects yen to depreciate in the coming months and Nikkei to move higher.

Also read: The missing piece in the global growth puzzle 

Below is the verbatim transcript of his interview on CNBC-TV18

Q: The World Bank and the International Monetary Fund (IMF) have put out a fairly positive view of the global economic growth in 2014. What is your idea of US growth? Will it continue to be robust and therefore the tapering programme will be maintained as planned?

A: It is important to understand why the economy is showing signs of picking up and that is because quantitative easing (QE) has driven up the stock market by 30 percent last year and also pushed home prices up 13 percent last year. So, that has caused household sector net worth to climb USD 21 trillion from its post crisis low and it is 12 percent higher than it was before the crisis started. This has created wealth effect; its fueling consumption and supporting economic growth.

However, if quantitative easing ends later this year then it’s likely that interest rates will then go up, stock prices would fall, property prices would fall and the US could very well go back into recession. So, for that reason I do not think they are going to end quantitative easing at the end of 2014 as it is suggested. I think it is going to continue on in 2015 and probably beyond.

Q: A word on Europe, we have seen the end of recession or so it seems. Will there be a recovery or do you see the European Central Bank (ECB) indulgence some kind of quantitative easing probably by some other name – long term refinancing operation (LTRO) or some other name?

A: Few days ago Christine Lagarde, the Managing Director of the International Monetary Fund (IMF) warned the global economic crisis is not over and she pointed out in particular the growing threat of global deflation. In Europe the inflation rate last month was only 0.8 percent. It’s well below where the ECB would like it to be and on top of that the European economy remains mired in recession and well below the level of gross domestic product (GDP) that it was before the crisis started.

I do think more stimulus of one kind or another is required in Europe - a further rate cut, more LTRO and ultimately even asset purchases, the way the Fed has been doing.

Q: Given that you are expecting quantitative easing in both these major economic groups. How does this leave asset allocation if the global economy is going to remain reflated? How will smart money move. Does it move back to emerging markets or does it remain in favour of developed markets?

A: The best way to play this in general is when central banks are creating lot of money you can expect asset prices to go up and when they stop creating a lot of money then asset prices are likely to go down. So, the trick is to try to anticipate in advance what the policy makers are going to do and that is what my work revolves around.

I have a video newsletter called ‘macro watch’ and it focuses on predicting credit growth and liquidity and government policy in order to anticipate how those things are going to impact asset prices.

Q: For the next six months what are you advising asset allocators, what should the prudent strategy be now?

A: It varies on country by country basis with Abenomics in full swing the Bank of Japan is creating three times more money relative to the size of Japan’s economy as the Fed is relative to the size of the US economy. So, it seems quite likely that the yen is going to continue to depreciate and the Japanese stock prices will continue to appreciate.

On the other hand in the US, for instance there will still be a lot of excess liquidity during the first half of 2014 because the Fed only intends to taper gradually. Liquidity will only start to become tight in the Q3 and then it will become very tight in the Q4.

So, the trick is going to be to try to anticipate whether the Fed is going to stick with its current taper schedule or whether they going to expand, extend quantitative easing in 2015 because as I expect, and when they announced they will extend in 2015, we will once again see a nice rally in stock prices and we will see bond yields fall and the dollar weaken.

Q: What does this mean for a country like India; foreign institutional investors (FIIs) flows were very robust in 2013. How much do you expect would come in 2014 and what is your assessment of the economy, is that on the mend?

A: The most important driver of the rest of the world is the US economy. When the US economy is growing strongly – that creates growth all around the world. In particular, when the US current account deficit, the trade deficit in other words, when it widens that is good for the rest of the world because the rest of the world can sell more to the US.

But looking out for the next three years it looks as if the US current account deficit is going to become smaller largely because of shale oil revolution; the US is importing less oil and exporting more petroleum products so that is going to mean a smaller current account deficit, less liquidity being thrown on the global economy, less Asian exports going into the US. Therefore it is going to create a difficult environment for the rest of the global economy.

Q: What will be the fund flows into Indian market look like in 2013?

A: I suppose in the first half of the year as people discount what they believe will be the end of quantitative easing - the fund flows will be tight but later as it becomes clear that there will be more quantitative easing than people currently anticipate, the fund flows will revive for India and for other emerging economies as well.