See US tapering in March; euro to strengthen: Citi

Considering the US just faced the budget and the debt ceiling issue, it is likely that the Federal Reserve may not do anything in terms of tapering in December, says Anil Prasad, Global Head-FX & EM local markets, Citi. He expects tapering to start by March 2014. With the US economy growing at 3 percent, there is no need for additional easing, he explains.

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On the other hand, the euro is at a two-month high. There is a lot of talk about the euro heading to 1.40 a dollar. Prasad says 1.40 should see the peak in the euro. But the US is still continuing with its QE programme, Japan has launched a massive increase in the monetary base and at the same time Europe is the only one shrinking the balance sheet of the ECB, and hence the euro strength, he explains.
Due to the huge increase in the monetary base in Japan, yen is likely to weaken to a great extent. Prasad sees the dollar-yen end this year above 100 and next year it will probably be in the 110-115 range.
As far as the Indian currency is conerned, he expects rupee to trade in the range of 60-62 for now. When the US starts tapering, the currency may depreciate a bit, but as long as the country focuses on lowering its current account deficit, things should be fine, he says. Below is the verbatim transcript of Anil Prasad's interview on CNBC-TV18 Q: Do you think Federal Open Market Committee (FOMC) meeting will be a non-event with the Fed continuing to state that tapering is not at least on us?
A: At this point given that we have just gone through the budget issue and the debt ceiling issue it is very likely that the Fed does nothing. The market does not assume that the Fed will start talking about ending Quantitative Easing (QE). The issue is at what point do we start that discussion. Q: What is your view in terms of when tapering will be on us? This government shutdown is slated to reappear in February.
A: It is slated to reappear and it makes it very complicated. My personal view is that it is very much a first quarter event and it is sooner rather than later. The last call in the September meeting was very close and as you know the market really did think that they were going to end the QE. People have to realise that this is additional easing, with the US economy growing at 3 percent you do not need additional easing. So at some point QE has to come to an end. Q: In that case you are clearly not expecting it up until December 31, 2013. You are clearly seeing it only as a next year event?
A: I see tapering as a next year event simply because the Fed will be cautious ahead of the renegotiation on the Budget and whether it is sequestration or they come up with a deal between the Republicans and the Democrats, plus the fact that you have got the debt ceiling issue in February that we talked about. So with that they will be a bit more cautious. The data coming out of the US now becomes muddied just because the government has been shut down and so that will normalise. So they need to see through all that. So I think it is first quarter event of next year. Q: Should the markets work with March as a possible time when tapering might set in?
A: In my portfolio investment that is our base case, that is what we are thinking.
_PAGEBREAK_ Q: Therefore how will markets negotiate? If March is thought of as the most likely tapering date as of now, how will fund flows behave? Do they continue into emerging markets like we have seen all through September and October in particular?
A: In general there is a lot of cash being held by the real money community and that money could be put to work. Having said that, if you know tapering is coming at some finite date in the future and if you are seeing liquidity conditions dry up in August and September you are not going to commit the entire amount. People will stay cautious. Q: Before we come to emerging market or Dollar Asia, let me first come to the immediate event of the way euro is headed - two year highs. Is there more juice left in this euro rally itself?
A: A lot of people are talking about 1.40 euro. Frankly I think the European Central Bank (ECB) would not be happy to see the euro at that place. Do not forget it is not just 1.40 euro. The euro has appreciated dramatically against the Yen, about 35 percent since the low. So this is a big change to probably the weakest of the three economies - Japan and US is doing better than Europe. I think 1.40 should see the peak in the euro. The issue of course is that the US is still doing QE. Japan has launched a massive increase in the monetary base and at the same time Europe is the only one shrinking the balance sheet of the ECB, hence the euro strength. Q: There is a Bank of Japan (BoJ), meeting and as you said 7 trillion Yen is on us and will come with the same ferocity. How much more does Yen weaken?
A: My view is that you will see Dollar-Yen end this year above 100 and you will probably see next year 110-115 range. So I am very much in the camp that you will see a much weaker Yen. Q: We were normally used to trending with euro. The day euro moved stronger inevitably or invariably the emerging market currencies would also strengthen. That snapped in August. We saw this fragile five especially going down. Do you think that at least the worst is over for the fragile five or do you think tapering will bring back something nearly as bad?
A: I think that the first time round – it was more of a surprise and so the move was much larger. Since then the five have taken actions to improve. They themselves realised, whether it is central bank intervention in Brazil of USD 60 billion or the measures taken in India to curb imports. There will be weakness of course if tapering comes to an end, but I do not think of the calibre and quantity that we saw the last time. The issue we really need to think about is what happens when the Fed actually starts tightening then it is a different story. Q: What do you think about India? There is a market moving event tomorrow, but nevertheless what is your sense about the rupee? Have we seen the worse or do you think when tapering comes rupee moves towards 65? What is the view immediately, say in the next quarter or so when it should be a ceteris paribus when the tapering should not happen? Do you think there is more room for the rupee to strengthen?
A: I think for now the rupee has strengthened as much as it is going to since its weakness. Our personal view is that it will probably stay in the 60-62 range for now. When tapering comes it may weaken a bit more, but to the extent that they take macro prudential measures to bring the Current Account Deficit (CAD) down that is the key thing the market is focused on today. It is more focused on CAD than anything else in the world, just because Foreign Direct Investment (FDI) is going down and trade no longer grows at the pace it was growing in the past, it is only 1 time GDP.
In that environment that is the sort of range we are looking at. When the interest rate hikes in the US come which we have not talked about then of course we will have to relook at the environment. Q: How are you expecting the dollar to trend in 2014 first half assuming the Fed will start to tighten and how does it move in the second half or whenever you think it will start hiking rates?
A: This cycle of growth in the US is very different than others. The reason I say that to you is because the US is becoming energy independent. Typically, when the US grows that is great news for the developing world, after all the imports go up and the developing world exports, wonderful news. This time around they are importing less and less energy and by the end of this decade the US might even become an exporter of energy.
So the trade deficits are falling as the US economy strengthens and the manufacturing base starts getting built up, because you have got cheap energy. So that is a very different dynamic than anything we have ever seen before. I remain very bullish on US economy.