John Davies of Standard Chartered Bank believes the US Federal Reserve will hike rates in September, but it is unlikely to cause any massive impact on emerging markets.
Davies further adds the volatility in the US bond yields were driven by the euro bund market and it is likely to continue for the short and mid-term.Below is the transcript of John Davies' interview with Sonia Shenoy & Reema Tendulkar on CNBC-TV18.
Sonia: The US yields have risen from 1.9 that we saw in mid April to about 2.4 percent last week. Now they are lower but is the worst over or do you expect some more aftershocks?
A: I think it is worth starting by saying that this wasn’t a US centric occurrence, this was volatility that was beginning from and emanating from the euro rate or euro bond market as the market reassessed or began to reassess the euro zone backdrop on the fundamental side. There are signs that growth was beginning to pickup a bit and we have seen oil prices rise of their lows, so there was a question mark starting to form around the kind of deflationary views that have been built into the euro area bond market. Now the very low level of yields there had lead to a high degree of relative value being seen in the US treasury market and decent levels of demand there holding down yields. As the concerns grew in the European bond market and positions were unwound quickly – that then spilled over the US treasury market.
However, I would say that within the US domestic economic data we have seen very weak Q1 and so far in Q2 data we haven’t seen such great improvement. Hopes have been a lot higher but the data still remain mixed at best. So I do not think that we are due to see some repeat of the mid 2013 taper tension, when 10-year treasury yield went 140 bps higher from May to September. So it lasted three-four months and it went much further than the move we have seen. I do not think we are in repeat of that situation but the volatility we have seen and the investor positioning unwinds have been triggered – that volatility could still persist for a short while or longer but we are talking about days or week or two; certainly not three to four months.
Reema: While I take your points that the German bund as well as crude were equally volatile but crude has gone to levels of nearly USD 69 per bbl and it has eased a bit even the German bund yields had hit levels of 0.72 and now slightly lower and that goes the same for the US yields as well. How are you reading these markets and is there more highs to come in the near term?
A: I think on the oil price side our house view is that generally there is further upside from here. If you look on three-six months horizon through the rest of this year but the big issue for market is we are seeing bottom forming in oil prices and realise that the deflationary impetus that come from oil prices is effectively behind us. The bond market therefore had to adjust to that and because positioning would become overstretched particularly within the bond market within the euro bond market – that volatility has been quite intense over the last week or two but now that those positions are perhaps coming more cleaner, the market is little more balanced and even if oil prices continue to trend gradually higher over the coming months, the initial turnaround in positioning has probably been seen. It is not to say that we won’t see a little bit more volatility in the near term and maybe we do mark a new high in yield but I do not think it will be significantly higher than what we have already seen. Nevertheless by the end of the year I would expect seeing bond yields start to move little higher on a broader more lasting basis but this bout of volatility will soon come to an end.
Sonia: After the taper tantrums of June 2013 most emerging markets like India cleaned up their current account deficits etc. An expert told us when the Fed hikes it won’t hurt anymore but in May this year one move in the US yields and emerging markets like India saw huge outflows. When the Fed eventually hikes whether it is in September or in December, do you think that we could see jitters in markets like India?
A: We do not necessarily think so. We do expect a rate hike to come to in September but we think the forward guidance, the messaging around that that the Fed is providing now and will still be providing then, will effectively hold the hand of the market through that process. So explaining that tightening will be very gradual process and the pace of it will be very much determined by the ongoing data flow and the economic backdrop. So I do not think we should necessarily get the shock that we have seen in mid 2013 when effectively the market was priced for the Fed being accommodated effectively for every like the quantitative easing (QE) infinity idea and that is similar to what we have seen emanating from the euro market recently. The market has begun to assess the European Central Bank (ECB) as in QE infinity mode and what we have seen is a back away from that but that doesn’t necessarily mean markets are now going to get scared about imminent tightening or very rapid pace of tightening from the ECB or from the Fed.
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