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Home > Business > Special

'Fed's hawkish stance to continue'

June 29, 2006

Sharada Selvanathan, Currency Strategist at BNP Paribas says that the Fed is going to hike rates by 25 basis points, given the fact that the market will not react very well to anything higher than that. She also says that the rupee will remain soft against the dollar, and will continue to be an underperformer against other Asian currencies.

Excerpts from CNBC-TV18's exclusive interview with Sharada Selvanathan:

What do you think might happen at FOMC meet?  More importantly what does the road ahead look like?

I think Fed is going to hike rates by 25 bps. There is some debate about a 50 bps hike but I think it is highly unlikely, given the fact that the market is not going to react very well to this.

If we have a 50 bps hike, we are going to see equity markets in emerging markets coming under significant pressure. So I don't think Fed is going to do that, I think a 25 bps is extremely likely.

I think more important thing to look at is the policy statement. I think there is likely to be some tightening and there is going to be some kind of firming in terms of their hawkish tone.

Ben Bernanke is not going to let there be any undermining of his credibility. Also the fact that the inflation expectation has come down, I think they are going to be quite clear that they want to hold that tightening bias, because they don't want inflation expectations to spike later on.

For the year-end what is the kind of rate you expect?

It is very difficult to say because a lot of that depends on what kind of statement comes out today. I think we will see this continuous hawkishness. The market will go ahead and price-in an August rate hike.

What we see is further hike in August and we could see the market going ahead and fully pricing this in. This all depend on the data.

The Fed had clearly said that they are very data dependant. If the data does slip on the negative side very quickly, then of course the markets will be caught off guard.

In case they go ahead and price-in an August hike but the data will suggest that US growth is slowing too quickly, quicker than what the Fed expects and hence the Fed might go and pause in August. So it is very difficult to say if it will be between 5.25 - 5.50 right now.

What would this mean for the dollar movement vis-�-vis the rupee as well as the other emerging currencies?

I think that the dollar will gain support on this interest rate as per expectations.  Now a hawkish statement would mean a continued support for the dollar. But I continue to believe that this would be very near-term and temporary.

I think that the market realizes that too many Fed hikes will probably see economic growth slow down quite substantially, but the market still wants to see this coming through in the data.

So only when the US data shows continued signs of weakening activity, whether it is the housing market or whether it is in terms of confidence, the market wants to see this clearly through the data and only when this takes place will the dollar come under pressure when the cyclical support is withdrawn.

In that light, what would your target be for the dollar year-end vis-�-vis the rupee?

We are going to see the Indian rupee remain pretty soft against the dollar. Based on this dollar support, there is also the fact that the Central Bank really does not want a very strong Indian rupee.

So I think that we could see the rupee still hovering around these levels. The Dollar-INR is moving lower, but at very a gradual pace. Generally, the Indian rupee would be an underperformer against the other Asian currencies.

Do you think, given the uncertainty ahead of that 5.25 per cent rate hike possible today, that we could see this trend continuing?

The sucking of liquidity will continue especially because we are seeing the interest rates rising globally; not just in the US, but also in other European Central Banks, and now the Bank of Japan is also thinking of ending their zero interest rate policy.

So I think that this is going to be the theme for the rest of the year, this sucking up of liquidity, which means that equity markets are likely to remain under pressure. I will be very cautious of going long into high beta markets.

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