David Bloom, Global Head of FX Strategy, HSBC thinks that a US Fed rate hike will not affect global markets as it has been anticipated and priced in.
*What are your views on the anticipated US Fed rate hike?
The Fed is saying that they are going to raise rates, but no one is working out whether the US economy needs a rate hike. We have forward guidance, and the Central Bank and the Federal Open Market Committee (FOMC) members are saying that they are going to raise rates on December 16, so who am I to say anything. If the Fed raises rates then the dollar will go down. The markets have been anticipating a rate rise and as this has been the most telegraphed rate rise which we never had. Since 2009 the Fed has been expected to raise rates, and it hasn’t come. I cannot believe that after three years of preparation and six years of anticipation of a rate hike which never happened, the markets are not ready for this. Is it the correct policy? Well, that is a different question; but are we ready for it, I would say yes.
Anticipating a rate hike, the dollar had rallied hard and anticipating a tightening, various policy measures have been taken by Central Banks across the globe. For example, we saw New Zealand cut rates in anticipation of a rate rise. Looking ahead, if we see a three quarter points rate rise by the end of 2016, on what basis should the dollar rally, as the increase has already been priced in. I am not buying that story.
I also find the concept of normalisation being touted by the Fed, extremely difficult to understand. Oil prices, copper prices, the transmission mechanism from low oil prices to the economy, the Japanese monetary policy, the ECB cutting rates by 30 basis points are all pointing to the fact that things are not normal. The growth of China’s economy is slowing from 7.4 to 6.7 per cent, so where is the normalisation. My point is that countries have tried to normalise and a good example of it is Japan, which normalised in 2006 after waiting for 16 years.
All indications point to a Fed rate increase. What are its implications going to be?
I do not think that it is going to have much of an impact. We think the dollar has taken off 0.7 per cent of US GDP growth this year. So the GDP is already lower than what it would have otherwise been, so it has already affected the economy. The Fed has put the market in a circularity, if the dollar rises from here, it slows the US economy and then we do not need a rate raise, as the dollar does not need to rally further. The Fed has already put a stabiliser in it.
There is a fear in emerging markets that there will be an outflow as the Fed raises rates? How real are such fears?
Such fears are unfounded. Did we see money flow out of the Euro, when they cut rates by 10 basis points? And did the Euro rally? It didn’t. The rationale economic argument would have suggested that it should have, but it did not happen, because it was anticipated and over anticipated. From an emerging market perspective, I think we need to get this rate rise over with as the anxiety and uncertainty is really hurting emerging markets.
A number of central bank heads have gone on record stating that if the US raises rates, then we will be forced to follow suit. How much merit is there in this line of argument?
That is wrong. That line of argument is the consensual view, which states that as the Fed cuts rates, the dollar strengthens, the yield curve strengthens and others are forced to follow suit and that is the easiest thing for me to turnaround and tell you. What I am saying is that the Fed rate rise has been priced in; the long bond by next year this time (December 2016) will be one and a half in its tenure. This is because yields will be pulled down by Japan and Bund yields on ten years in Germany will be 0.2 per cent. It’s a disinflationary and deflationary world that is going to pull US yields down. So you do not get a steepening of the yield curve, you do not get a rally in the dollar, and countries with weak growth like Mexico, South Africa etc. will realise that they do not have to raise rates and the world will become a lot more diverse again.
Where do you see future growth going globally?
We have cut our numbers for China by half a per cent and now we have just cut our numbers for Brazil. The US will poodle along with 2 to 2.5 per cent growth. It is not a year of growth, but when you look at oil price, copper prices, it has already told you that. Low growth should not come as a shock to anybody. Growth is sluggish. We have tried — monetary policy, fiscal policy, zero per cent interest rates, negative interest rates, quantitative easing, and currency devaluation and here we are sitting eight years after the crisis talking about low growth; so something different and more structural is going on and we have to discover what it is.
What are your thoughts on oil prices and where do you see them moving from $30 per barrel levels?
Let me give you an example of how oil prices used to work and how it works now. The marginal propensity of oil producing countries to consume used to be low, and the marginal propensity of oil consuming countries to consume used to be high. So when oil prices dropped you would have a transfer of wealth from low marginal propensity consumers to high marginal propensity consuming economies in the West. Secondly, Central banks in the West would say, we have low inflation so let’s cut interest rates. Three, real incomes would go up, as inflation would be down. So there would be three different mechanisms in place that would stimulate growth. This would help in bringing recovery in the West, which would get quite powerful and that would help oil prices to go up again and the cycle would reverse itself. Today, we have low marginal propensity consuming economies in the West and high marginal consuming economies in oil producing nations, building infrastructure projects, hospitals, hotels, universities etc. So now you are transferring wealth from high marginal propensity consuming economies to low ones, which is bad for world growth.
Secondly, there is low inflation in the West; but we do not have the reaction function, where we can cut rates and stimulate demand. So the second mechanism is not working. The third mechanism is working as real income is boosted, but the problem is that in economies that are highly indebted, what can be done with the extra money? It can be consumed or used to pay off debt, or a bit of both. Earlier, you would have all the three factors working in tandem. This time around you have half of those factors working. So what we have discovered is that we have low oil prices which reflect a lose-lose situation, rather than a transfer from one set to another, which would help the cycle to change. The problem this time is that this time the cycle is not working the way it used to. Would you say this is normal, so when the Fed says that it is normalising, I am not sure what they mean. Everything that I am looking at is abnormal or different.
Given depressed commodity prices, particularly oil, what are the choices that lie ahead for GCC states?
I would say, you may get a bounce based on luck, but otherwise don’t look for much. You cannot get away from the fact that there is an economic cost; and how you bear that economic cost and how you balance that is an issue.
*Note: This interview was done before the US Fed rate hike on December 16, 2015