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Last Updated : Dec 15, 2016 09:18 AM IST | Source: CNBC-TV18

Fed's hawkish commentary a surprise; EMs to remain under stress

Fed chair Janet Yellen also said that there is a possibility of three hikes by the US Fed in next three years. This is likely to make investors cautious, believes Seth Freeman of CEO & Chief Investment Officer of EM Capital Management.


The US Federal Reserve on Wednesday raised interest rates by 25 basis points while signaling that rate hike is likely to continue next year with the new government coming.

Fed chair Janet Yellen also said that there is a possibility of three hikes by the US Fed in next three years. This is likely to make investors cautious, believes Seth Freeman of CEO & Chief Investment Officer of EM Capital Management.

Some pause is expected before the flows return to emerging markets, he added.

Hans Goetti, Banque Internationale À Luxembourg said that if dollar continues to strengthen, it would slow down the growth in US. A lower dollar is needed in 2017.

Goetti further said that dollar strength has run its course and its weakening will be positive for emerging markets (EMs) who could be the asset class in 2017.

James Glassman, senior economist at JP Morgan too said not much increase is expected in dollar. 

However, Khoon Goh, Head of Asia Research, ANZ Research believes that there is more upside to for dollar to move. For EMs, currency will be on the back foot for next 3-4 months. Fund flows too are likley to remian under pressure. 

ANZ Research has a rupee target of 70.5 against dollar by end of 2017. Rupee, he said, is overvalued at current levels. Goh remains cautious on India due to domestic factors like demonetisation.

Below is the verbatim transcript of Hans Goetti, Seth R Freeman, Khoon Goh & James Glassman's interview to Ekta Batra & Mangalam Maloo on CNBC-TV18.

Ekta: What is your reading in terms of Fed's decision? It seems to be much more cautious than what was anticipated?


Goetti: I am not sure whether the market really reacts to the Fed's decision because the Fed decision was a foregone conclusion; it was build into prices already. However, what market is now doing is to somewhat get back to reality. We had the Trump rally, as it was called and it was built on hope and there is hope and there is reality.


Ekta: Yes, 25 bps was a foregone conclusion but consensus was expecting only one hike going into 2017 - and that is not the case, plus Yellen was decisive of the fact that she is going to see through her four year term. So your thoughts on the fact that maybe that part was little more hawkish than anticipated?

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Goetti: That is right. I think a lot of people are saying there will be two rate hikes in 2017, but remember we started 2016 with a prospect of four rate hikes and we got only one.


I think what is happening here is maybe the transmission mechanism will be the currency; I mean we had a very strong dollar because the Fed is tighter than all other central banks and it is going to be interesting to see what the European Central Bank (ECB) is going to do. The ECB has told us that they will taper sometime next year and it is also going to be interesting to see what the Bank of Japan is going to do. So we have to see what other central banks are doing because currently exchange rates are driven by the relative monetary policies between central banks.


Now, if the dollar gets too strong that in itself would help to slowdown the US economy and if interest rates, at the long end, go up too high, that slows down the economy as well. So inevitably we would need a lower dollar sometime in 2017 otherwise the economy would slowdown a lot more and of course then we would have a prospect of, maybe again, a much more dovish rate, but not to forget that the Fed will be a lot more dovish in 2017, if you look at the composition of Federal Open Market Committee (FOMC). So I am not convinced that we get those rate hikes.


Mangalam: What do you make of the Fed’s commentary last night, 25 basis points hike, which was expected and at the same time the anticipation of three hikes in 2017 as against expectations of about one or two?


Freeman: I would say that the indication of the possibility of three hikes in the coming year was a little bit of a surprise although Janet Yellen made it clear that nothing is certain yet and that it is subject to adjustment.


Ekta: What is your sense in terms of how the Indian market might react to the Fed possibly raising rates three times in 2017?


Freeman: It is more going to be a function of perceptions of growth in the United States. Of course it is inflation in growth that will affect the Fed’s policy decision making. I really think the issue is going to be general economic growth and corporate earnings into 2017. Obviously, we also have some currency foreign exchange (FX) issues as well because of the interest rate differential.


Mangalam: What would you make of the fact that the event that the street was building up over the last few months, now the event is out of the way with the outlook. There is some clarity which has emerged. What is the way forward for the markets in the world, the emerging market (EM) pack as well as the developed markets and India in specific?


Freeman: I think that basically interest rate movements or marking movements are forward future oriented and so this quarter point increase, 25 basis points was well anticipated. However, I do think the question whether it could be three increases may make the investors a little more cautious about emerging markets in general. In India where there is continuous pressure to reduce interest rates and that could have some terms of INR-USD that could put some pressure on the rupee.

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Ekta: Your sense in terms of the fact that there could be three hikes in 2017 from the Fed and do you think that eventually as Trump’s policies come through in terms of economics those expectations could recede as well?


Goh: The Fed was definitely a lot more hawkish than what was the market was expecting. Certainly, relative to our expectations we were only forecasting two rate hikes in 2017. So the fact that the Fed thinks that the economy is on much sounder footing and could handle three rate hikes is certainly very bullish for the US dollar and very bearish for bonds. I think a lot will depend on fiscal policy.


If the fiscal policy do take place including tax cuts and infrastructure spending and that starts to really have a material upside impact on US growth then I think three rate hike is pretty reasonable with a risk that perhaps there might be a little bit more aggressive Fed rate hikes towards the end of next year in 2018 as well.


However, it suggest to mean that the dollar will stay strong in the near term and US yields looks to go higher which will have a quite negative implications for emerging market currencies.


Mangalam: In that case how would you advise or what kind of trades do you see as far as the moves between the emerging markets as well as the developed markets are concerned primarily on account of the strength that we are seeing in the dollar and do you think this is the top as far as dollar strength is concerned?


Goh: I don’t think this is a top for dollar strength. I think that is definitely upside for the dollar to go. The reason why I feel that there is more upside is that what we are seeing here is that the market factoring in the US side which is more hawkish Fed, probably stronger US growth in fiscal policy in the US. Let us not forget as well on the other side of the coin, countries like Europe for example where a huge amount of political risk coming up in 2017 and that is not really priced into the euro currency at this stage.


So, once we get closer to those key political risk such as the Dutch, Italian and French elections because that will seen as more of a political risk premium getting priced into the euro which will lead to further euro weakness perhaps even towards parity and of course the flip side is that is going to be further strengthen the US dollar.


I think for emerging markets currencies will continue to be on the back foot probably for next three or four months, as we are going to see further pressure on out flows as fund managers around the world will reallocate their portfolio reducing how much they invest in the emerging markets and shifting more towards the developed markets.

Mangalam: What do you make of the Fed decision that came by yesterday, 25 bps hike was more or less expected but what do you make of the anticipation of three hikes in 2017?


Glassman: I wouldn't make too much of that because we do not know exactly the thinking that is going on. A few people changed their mind and moved up from two to three. However, what is going on is they think that in the Trump's administrator there will be more fiscal action which will boost the economy more - that doesn't show up in the forecast but Janet Yellen kind of hinted that.


So I wouldn't make much out of it because it changes a lot; a year ago they were talking about four moves in 2016 and did one and then  they went to two moves in 2017 and now they are talking about three moves - that's the medium forecast at least. So we will see what happens.


If the economy turns out to be stronger as a result of fiscal actions as some of these people anticipate then maybe the Fed might do three instead of two moves but the key thing is they keep telling us that it's going to be a gradual process and it is going to be a proportion to how the economy unfold. So I do not think it is going to be very disruptive.


Ekta: Your thoughts with regard to the dollar index. There is a mixed view on whether the dollar index is going to strengthen much more going into 2017. This also comes at a time where Trump wants to boost the economy when it comes to efficiently manufacturing within the United States and hence a cheaper dollar would benefit then. So your sense in terms of where exactly the dollar index would possibly head in 2017?


Glassman: I doubt that the dollar is going to be going up just because the Federal Reserve is raising interest rates because if you think about it the Futures market already reflects a view about the Fed. So if the Fed moves interest rate up in line with the market's thinking - that shouldn't come as a surprise and my guess is a much of that is already discounted in dollar's performance. It probably depends more on whether we get actions out of Trump's administration that boosts the economy's growth potential or seen as economic positives. However, what would get the dollar moving higher would be policies that turnout to be much more pro growth, it actually encourages investors to move money in the US, but I think there are limits on what can be done there. So I do not expect to see much of an increase in dollar.

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First Published on Dec 15, 2016 07:00 am
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