The US Federal Reserve is likely to remove the word ‘patient’ from its forward guidance, is the word coming in from Arnab Das, managing director, macro-strategy, Trusted Sources. However, he believes the process of interest rate hikes will be gradual.
Inflation in the US is still low and productivity gains are limited, based on which it is expected that the 10-year yield curve will flatten.
In the event that ‘patience’ finds a mention in the Fed statement and the guidance is dovish, Das believes it will be good for risky assets such as the US equity market, emerging markets and currencies.
Below is the verbatim transcript of Arnab Das's interview with Sumaira Abidi & Reema Tendulkar on CNBC-TV18.
Sumaira: What is your own expectation from what the Fed could do, the range is quite wide but is your sense that the Fed could continue to remain patient especially given the kind of jobs data that we have seen recently?
A: I think there will probably have to be some kind of a change and I guess the betting is and I tend to agree with that that the forward guidance will be removed or at least mitigated further. So, probably the word ‘patient’ will come out and then data dependency will become more important so there is less certainty about the timing of the rate hike.
I think the good news in a certain sense is that the rate hiking process is still likely to be quite gradual and to a fairly low eventual peak for Fed funds because although the headlines in the labour market and in the economy as a whole are quite good, the details are not so supportive.
Reema: What do you expect the market reaction to be, the US 10-year yield is at 2.06, if we do hear the Fed remove the word ‘patient’ where do you think the yields will go in the US?
A: I think people are starting to expect this will happen and so there is a great deal of strength in the dollar and there has been some steepening in the yield curve. However, now there is going to be some flattening because the reality is that although the economy is performing again robustly as far as the headlines go, inflation is quite low still. Although there is an issue because of productivity gains having been quite limited, the overall situation is not one of very rapid increases in inflation rate which would be the main determinant of the 10-year bond yield and the level of the yield curve.
Sumaira: What about emerging markets then? What is your expectation about how emerging markets themselves could trend given the two scenarios, a) that the Fed continues remaining patient or b) that they go ahead and hike rates?
A: Well, if patience remains and therefore the statement is more dovish than people have been worrying about then of course in the very short term that is going to be quite good for ‘risky assets’ including US equities and emerging market currencies and so on. If patience comes out, if there is less forward guidance, if there is more uncertainty, there is likely to be more volatility and that is not going to be so good for emerging markets and for currencies in particular although a good deal of this is already factored in to the behaviour of market participants. So, the knife in emerging markets has been falling. We will continue to see volatility remaining high but also quite some divergence across countries within the EM space.
Reema: But right now you believe the removal of the word patient is probably priced in into the global equities?
A:May be not completely priced in but substantially priced in. We have seen a lot of action already.
Reema: How much do you think the Fed is going to talk about the strength in the dollar and do you think that will add that lid of caution in their assessment?
A:They have been talking about the dollar on and off which is quite unusual. It is not unprecedented for the Fed and that will probably remain part of the debate and the discussion because even if it is not very prominent today, it will be there during the course of this tightening cycle because although they won’t actually explicitly go as far as trying to talk the dollar down, they will continue to try to inject some uncertainty and some volatility into the dollar so that it does not become a one way bet because that clearly is bad for the markets in general and it is also quite bad for the US economy.
Sumaira: Closer home to you there is later this week the European Union Summit that will take place. We have seen a recent more defiant Greece, what are you expecting on that front? The relationship between Greece and Germany has already deteriorated quite a bit, how could negotiations progress on that front?
A: Well, when you have this sort of a situation where two countries that are at loggerheads with each other, it sends the message that things will continue to be difficult. The risk of Grexit that is still there - or as the Germans are now apparently calling it 'Grexident' - it is still very much a major risk but what I would say against that is the threat of contagion systemic risk is much less than it was in 2011-12 because of Draghi’s statement, ‘whatever it takes, we are going to do,’ because of the flushing out the Outright Monetary Transactions (OMT) program and indeed because quantitative easing (QE) has begun.
So, I would say that balance of power has tilted from Athens to Berlin and so nobody is going to want to see Greece leave right now or right away or indeed if at all if it can be avoided but the hard line, the tough line is going to continue and so that is going to be an issue to contend with as particularly a problem for Greece itself.
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