US Fed may not raise rate above 5.5%

Glenn Maguire, chief economist (Asia Pacific) at Societe Generale, says that the Fed may raise rates once more, before pausing.

He adds that it is unlikely to see the Fed rate move above 5.5%.

Further he says that Asia will see tighter liquidity conditions, but he doesn't see repatriation of funds out of Asian EMs.

Excerpts from CNBC-TV18's exclusive interview with Glenn B Maguire:

Where do you see rates moving both globally and in India from here on?

When we look at US, we clearly are approaching a period where the Fed will pause. However the strong core inflation readings we have seen are likely to suggest that Fed will raise rates one more time to 5.50%. After that we are going to see a pause in Fed funds rate and our view is that 5.50 % would be slightly restrictive.

There may be potential for Fed to ease policy in 2007 if we see a slowing of US consumer.

Asia is somewhat more de-coupled from the tightening process. We will see China and Japan raising rates in coming months and also move into tighten liquidity. So looking at India as well, I think we will also see moves to tighten liquidity. Inflation remains a concern and I think across Asia one of the investments themes for the year ahead would be tighter liquidity conditions.

Are you expecting to see liquidity conditions globally tighten a whole lot more in terms of risk aversion as well?

I don't necessarily think it would be risk aversion. Obviously in the past three years there has been enormous liquidity in the global economy, which was a function of very accommodative monetary policy settings. A lot of that excess liquidity flowed into what we consider as peripheral assets such as emerging markets, bonds and emerging market equity indices.

In May-June we did see a re-pricing of risk and we did see some outflows. But we did see bond spreads in Asian markets remain quite tight. So that suggests there wasn't a great deal of capital outflows from Asia. So I don't think liquidity withdrawals we are seeing will necessarily reflect itself in a re-pricing of Asian assets.

But I think the inflows, which we saw were also supportive, but are likely to slow down. But I don't think there will be a repatriation of funds out of emerging Asia. There has been a significant structural improvement in these economies in the recent years.

What is your sense of how things will pan out in the foreseeable future in the next 3-4 months? Do you see too many inflows coming in, because we got used to last year of some serious inflows coming into emerging markets. Do you think it is too much to expect that over the next few months?

We are clearly

seeing some volatility at the moment and we are seeing a pause basically in asset allocation decisions as a result of that. I think once we have clarity on the Fed, once we have arrived at a view that the Fed has stopped raising rates or pause, we probably will see fund managers and investment managers re-visiting their asset allocation decision.

Now when they look around the globe they come to know that the epi- center of global growth is going to be North Asia. If Japan and China are going to grow extremely strongly that will have a spill over effects on rest of Asia and particularly to India via services dynamic, if we do see growth globally rotate towards investment led growth.

In terms of where the growth will be concentrated in the next two years, it will still be an Asian story. Given that I think Asia as an emerging market class is preferable to Latin America, or Eastern Europe. I think Asia will perform quite favourably relative to other investment classes given a very strong growth dynamic and very supportive fundamental backdrop.

What did you make of the move by RBI in India? Do you think that will impact growth in anyway for a market like India?

In a sense services tends to be as not interest rate sensitive as treasury or industrial activities. So I don't think it will have a significant impact. Particularly given that a lot services are sourced from offshore and it is a very large invisible component in that. So I don't think the hike will have significant negative effects on the Indian economy.

Around the world the pulse of inflation is clearly stronger than what the Central Banks were expecting three months ago. So it is an appropriate policy response we are seeing globally, in Asia and more specifically in India, to normalize monetary policy and to take policy perhaps to a slightly restrictive setting.

How are you expecting equity markets in the emerging markets to perform in the next 6-8 months?

We are generally seeing a re-pricing of risk over the May to June period. When we look at emerging markets, policy both monetary and fiscal in Asia has become more transparent. We are seeing very solid growth dynamics and we are likely to see Asian currencies appreciate against the US dollar over the next two years.

So, all that makes investment in Asian equity markets quite positive at this stage. I think we will see a resumption of capital inflows into Asia and that would be supporting Asian markets. So in general we are positive on outlook for Asian equity markets over the next 6 months to one year.

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