CNBC Transcript: Ray Farris, Head of Fixed Income Research APAC, Credit Suisse
20 March 2018
Following is the transcript of CNBC's interview with Ray Farris, Credit Suisse's APAC Head of Fixed Income Research, at the Credit Suisse Asian Investment Conference in Hong Kong. The interview was broadcast on Squawk Box on 20 March 2018.
All references must be sourced to a "CNBC Interview'.
Interviewed by CNBC's Bernie Lo and Akiko Fujita.
Bernie Lo (BL): Ray welcome, thank you for joining us.
Ray Farris: Thanks for having me.
BL: Good on you to join us. A foregone conclusion that the one rate hike is definitely in the cards. Beyond that, you get, you run the whole gamut of opinions don't you?
Ray Farris: Well the Fed is definitely going to do three this year. I mean they've signalled that the economy is strong. It's got an extra tailwind from the tax cuts that's going to feed its way through. So the markets are priced for three hikes. The real question mark is how are they going to change the dots and Powell's first congressional testimony he's signalled that the dots probably go up. He probably moves them up to four hikes for this year. I wouldn't be surprised if they actually push him up a little bit for next year as well.
Some of the senior Fed officials have begun talking about the neutral rate creeping higher as the economy seems to be growing more strongly, more persistently. The tax cuts helping with that potentially. So I think the markets are looking for some increase as you say the question is, well you know how much and how quickly.
AF: You pointed out earlier you know we've been talking about three rate hikes for some time. It seems that the expectation is there. The question is you know for all the talk, are the markets prepped for it. If we hear language coming from Jerome Powell about the potential, you know he's never going to say we're going to do four rate hikes but the potential for some accelerated hiking, how do you think the markets will respond?
Ray Farris: Well markets are fully priced for this year. The Fed funds futures for three hikes. And there's a bit more next year. What would be a real surprise is not so much that they take the dots to four this year but rather if they were to take the dots to four this year and push up the dots meaningfully in 2019 crucially beginning to talk about the neutral rate. So remember that for the last several years the Fed, many in the Fed John Williams in San Francisco Fed in particular, have talked about a neutral rate, that zero to a half a percent in real terms. Now they're beginning to push that up. That affects where markets are going to think about where rates are going to be. Not just at the end of this year, but in two or three years' time and that affects the entire structure of the front end of the curve. So that would be a big shock.
BL: Ray, where is there, I mean the trajectory obviously for the topic at hand here is very well-known, Asia fixed income didn't escape the correction that we saw in February. But you're kind of back to prescribing Asian fixed income on a local basis not a dollar basis right now, is that sort of the flavor of the month right now? Or where is the mispricing where's the unlock capital value right now?
Ray Farris: Well the regularity in emerging markets is that when U.S. yields rise, emerging market yields rise. The real question is about which asset class performs best. So that's about spreads and that comes down to whether U.S. yields are rising because growth is good and inflation is reasonably controlled or whether the problem is inflation's beginning to really rise and the Fed's having to chase it and tighten aggressively. So the way that we think about this is spreads will have some room to tighten further because we think the Fed's tightening mainly because growth continues to be pretty good. Inflation has been very controlled. We think it's going to creep higher but not enough to really force the Fed to accelerate powerfully. There are not a lot of markets in Asia where we think local currency yields are particularly attractive simply because they're quite low. There are a few. Indonesia is one where yields both from an international perspective and for domestic reasons look interesting. We tend to think what'll happen here is over the next several months, treasury yields will grind a little bit higher, local yields are probably be flat, maybe a little bit lower and spreads will tighten.
AF: I want to touch on currencies just a bit because you know traditionally, if the Fed hikes obviously that would be good for the dollar. And yet we've seen dollar weakness with the greenback down about two percent on the year on the back of concerns about the fallout that could happen from these trade tariffs the White House has announced. Is there more downside pressure right now?
Ray Farris: Well you know when you say that rate hikes help the dollar, that's true, but really only at certain points of the Fed rate hike cycle. It's been a regularity since the end of Bretton Woods in the early stages of Fed rate hikes have actually seen the dollar weaken for a period of time. You really need to get the front of the curve up a lot relative to trading partners and you've got to get the yield curve quite flat, so that if people want to earn U.S. yield, they have to do it unhedged. And right now there's still some carry-on rolled out on the curve that can pay for hedging. Markets don't like the expansion of the trade deficit and the expansion of the fiscal deficit. As you say just policy in the United States is quite confused. Markets don't like the idea that the U.S. is going to turn hostile to capital flows that have been helping to finance those deficits particularly Chinese FDI. So in total, U.S. yields are a lot higher. We think the dollar can continue to weaken.
BL: Wow. That's actually, this has implications mid-term and long term if that comes true. If what you're saying comes to pass, then one of the ways to get into this market and benefit is to actually get out of the short and get out of the mid and get out of the spot market and say, leverage into long dated U.S. Treasury strips or something. So basically use the power of leverage and go out because you're assuming that the deficit is going to create, I don't know, dare I say recessionary issues in the economy down the line?
Ray Farris: I wouldn't go that far. I think recessions are generated mainly because the Fed gets behind the curve, inflation goes up to a level that forces the Fed to create a contraction in the economy to squeeze inflation out. And that's just not where we are. You know most of the inflation data and most of the leading indicators for inflation still look really very benign. So the Fed looks to be running, you know, in this cycle, fingers crossed, you know, for the first time and perhaps ever, dead in line with where it should be. And so the economy can probably continue to grow. Our forecast for US Treasury yields are for them to basically go up just above three percent by mid year around 3-30 toward the end of the year at tens. Those aren't really big selloffs.
BL: Ray, can I - let me do a turn across the Atlantic here because we haven't really addressed this yet. But it's looking like this Brexit thing which was looking so dicey for a long time. It looks like it's finally maybe locked into the gear. Right now they found some sort of early agreement with the EU over the Irish border and all that. You've probably seen the news, does this change the landscape at all for Europe for the European credit market?
Ray Farris: Well that's a really good question. And sitting out here in Asia…
BL: It's a huge wide open question.
Ray Farris: It's a huge wide open question sitting out here in Asia. I'm not probably the best person to think about European credit. The thing that probably stands out for us in the way that I think about all of this stuff for our region is it doesn't look like Brexit is really going to affect the European economy in a way that's going to take the ECB off path. So the ECB is grinding its way toward an exit from buying bonds. We think that will probably happen in September, then a taper and then rate hikes and that'll have a couple implications. One is, it will help support the euro and keep the dollar weak, which feeds back into this region because if the dollar is a weak currency against the G10 currencies, it's a weak currency against emerging market currencies. That's just the way the emerging market currencies trade. They've followed dollar G10 directionally. As we get into the end of this year and into next year, with both central banks now beginning to tighten, particularly next year, liquidity conditions are going to tighten up and we're really going to kind of begin to feel it especially in local currency markets. That's not a story for the next six months. That's something you know later in the year, really into next year. I think right now the key thing is Europe continues to grow strongly. Markets are going to continue to look for the ECB to end bond buying in September, and that's going to continue to help the dollar. Sorry, help the euro.
AF: Since we're on the topic of central banks, I wonder if we can just bring in one more into the conversation which is of course in this region, the Bank of Japan. Governor Kuroda on the one hand seemed to have suggested that, look what we're going to continue normal, or will we will perhaps start looking at normalising in 2019. That's still a way off. Is there any case for JGBs right now?
Ray Farris: Well I mean I think that the way to look at Japan right now is there's just no moving parts in monetary policy in Japan. The BOJ may cut back its bond buying a little bit, but within the context of its YCC targets. And the key reason for that is the yen is under pressure to appreciate and it's going to remain under pressure to appreciate. So the Bank of Japan is going to find itself unable to really do much in terms of tightening policy backing away from this easing as long as the yen is strong.
AF: And the yen is so beholden to external factors.
Ray Farris: That's right.
AF: We'll continue to track the rates and we'll get insight there Ray Farris joining us from Credit Suisse here on the ground at the AIC.