Three Fed rate hikes over 12 months is reasonable: Luke Spajic, PIMCO

 In an exclusive interview with ET Now’s Tanvir Gill, Luke Spajic, PIMCO, says will be very surprised if Fed tries to move aggressively going into 2017 unless they saw extraordinary change in the data. Edited excerpts

Tanvir Gill: When can Fed be expected to raise rates? Will it do it at all this year?

Luke Spajic: PIMCO has had a view that the rates would be lower for longer for quite a while. Our thesis of the new neutral has always indicated that we do not think that the Federal Reserve will hike anyway near where the blue dots indicate many-many years out. That said, we actually think that three hikes over the course of 12 months is reasonable and they could start in December. It is very,very data dependent but they could start in December.

Tanvir Gill: Sure you are calling for a December rate hike and then perhaps two-three hikes in 2017. What gives you the conviction that post the second rate hike that may come by in December, the Fed will act more quickly into the new year?

Luke Spajic: The precondition is the need to be more hawkish. They need to be convinced that they are going to get ahead of some acceleration in inflation and growth and employment is strong enough for them to be able to do that. You can see from the number of votes and number of dissents that are on the FOMC that right now they do not have an outright majority and it will be very surprising if the Fed would move at a time when it does not validate what the markets are thinking. I will be very surprised if they try to move aggressively going into 2017 unless they saw extraordinary change in the data.

 Tanvir Gill: But what would the pace of hikes in 2017 mean for Asian markets or high growth emerging markets where money allocations have gone up through 2016. Would a hawkish Fed scale back your view on emerging markets?

Luke Spajic: It’s a very good question and very timely as well. Among many things to note is this move by Fed that is being anticipated and most investors would agree that the Fed would like to hike rates and they should try to do it through the course of 2017 and not it in a disorderly or very rapid way. If that was a given, growth rates are beginning to improve in emerging markets. Even countries like Brazil and Russia are moving out of recession in 2017. The Asian economies are growing steadily. Certainly Asian growth is at a 15-year low but it is still in the 4% to 5% range across the board. China is still according to official numbers in the 6s and so fundamentally things are pretty strong.

The technical picture is even more interesting because developed market assets need to be able to cope with an upmove in the Fed rates. Equity markets need to cope with that kind of move but if you look at emerging markets growth, the yields are a lot higher than developed markets. Most importantly, emerging countries will rely on their currencies to adjust id they have to. No one is really defending any kind of currency regime right now. But let me caution that if you have a very hawkish Fed moving very, very fast, it would unsettle all markets.

 Tanvir Gill: India for as long as I can remember since the new government came into power has been building the case for a ratings upgrade. Do you think growth trends are roughly at about 7-7.5% and now there is a potential for 8% as well? Do you think the management of twin deficits plus improving investment climate merits the case for India’s sovereign rating to improve?

Luke Spajic: It is moving in the right direction and it may be a story for 2017 but when you think about what it will gain, the upgrade will focus on structural reforms and passing the GST was a landmark move. The improving external imbalances have come a long way and especially the oil price not moving far up from here is a significant help. As for the growth rate, although there are some issues around whether the numbers are entirely accurate, I think you get that kind of a problem with lots of emerging countries. The numbers suggest pretty strong and robust across the board growth rate. Coming to inflation, if the framework to contain it that was put in place by Governor Rajan is adhered to rigidly, then all these factors point towards a very strong likelihood for rerating next year but we will see how that the story evolves over in the next few months.

 Tanvir Gill : As an FII, let us talk about the macro story as well. How do you view India as a reform story? The macro trends on growth and inflation as also how those data points would influence the new monetary policy committee that has been set up to work out the course on rates?

Luke Spajic: So on the reform story we cannot stress enough. Just passing the GST was a landmark legislation. Now comes the hard part of implementing it. I think 20% of the story may have been passing it and 80% comes from implementing and making sure it becomes something that works effectively. With regards to RBI, we do not know the new MPC members. So we need to get to know them just like the rest of the international community needs to get to know the new members but we believe in the framework.

 We think the fact that inflation should over time be brought toward the target with a range and as long as the central bank is focused on maintaining that framework and maintaining those targets and trying to work within those targets, there will be a great degree of investor confidence around the story. It is contingent upon a number of factors where the growth rate depends on whether the oil price goes up significantly or whether there is any loss of confidence but behind all of this, we are yet to see significant progress being made in banking sector reforms.

 Tanvir Gill: What do you expect from the RBI under the MPC model? Three members are from the government and they are all respected economists plus there are three members from the RBI the governor as well as the Deputy Governor included and they will all come together to decide the future course on rates. Do you see transition challenges?

Luke Spajic: The most important thing is we are going to be focusing on what kind of signals come out from the RBI..