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Emerging markets tied to liquidity: O'Sullivan

June 28, 2006 11:26 IST

Michael O'Sullivan, Strategist at State Street Global Markets, believes there will be less liquidity and higher rates will continue to tame the emerging markets or the bull markets that one has seen over the last few years.

Excerpts from CNBC - TV18's exclusive interview with Michael O'Sullivan:

How have you read the moves in the emerging markets and India specifically over the last couple of weeks?

One of the very strong trends that we have seen in the last two - three years is the aggressive institutional buying in emerging markets. What is interesting now is that in the last seven weeks, they began to sell down and still continue to sell emerging markets. Broadly speaking, the fact that they build up large positions in emerging markets, mostly in Asia, means they now have the scope to continue to sell these down.

We see very few signs of institutions, globally, moving back to emerging markets. I think that is just as much the case for India, where we saw very aggressive selling in late May and early June. Institutions aren't buying India yet, but they have stopped selling as aggressively.

What do you think market is factoring in, in terms of what the Fed will do? Will that in turn impact liquidity or inflows back into these emerging markets?

Generally speaking, I think emerging markets are definitely tied to liquidity. In emerging markets, bull markets began may be three years ago with the provision of liquidity and it is no

surprise that is coming to an end as Central banks in US, Europe and around Asia are beginning to tighten interest rates.

I think the interest rate markets are looking for two more rate hikes; 25 bps each from the Federal Reserve. Some people are even saying that they will raise by 50 bps this week. If they do that, it will raise uncertainty over Fed's policy.

What sort of an impact would that have on emerging markets and India specifically?

I think low liquidity and higher rates will continue to tame the emerging markets or the bull markets that we have seen over the last few years. It would probably have a greater impact in countries like China and related markets like Hong Kong because the working of their financial systems are more intrinsically tied to the US interest rate markets.

Any anecdotal evidence on what has been happening with some of these emerging markets funds, or BRIC funds after the sharp knock?

I think one interesting thing to note is where they are putting their money. A lot of global funds that invested in emerging markets seem to continuously put their money to work in the Europe and US markets. They are going for the safe havens.

We are seeing some selective buying of some more developed Asian markets like Hong Kong. But we are still seeing selling across most of the other emerging markets and certainly in Asia.

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