Kevin Warsh is no hawk and Fed rate hikes look unlikely: Julius Baer

Mark Matthews, Head of Research Asia at Bank Julius Baer, does not expect the Federal Reserve to raise interest rates despite concerns among some investors about a more hawkish stance from new Fed Chair Kevin Warsh.

He said Warsh has previously argued against raising rates in response to productivity-driven economic expansions, drawing parallels with the internet-led growth period of the late 1990s.

Matthews expects oil prices to fall to $60 per barrel by next year, adding that a sustained ceasefire agreement and uninterrupted shipping routes could support oil-sensitive economies, including India.

The outlook for India, however, also depends on global capital flows. Matthews noted that while lower oil prices, Reserve Bank of India (RBI) measures aimed at attracting deposits from non-resident Indians, and tax changes for foreign fixed-income investors are supportive factors, the US continues to attract investor attention because of strong corporate earnings growth linked to artificial intelligence.

According to Matthews, earnings growth in the US could be around 20% this year and remain in high double digits next year. He said India does not currently have a comparable AI-driven earnings cycle.

Matthews cautioned that predicting the end of the AI-led market rally is difficult. Drawing a comparison with the dot-com era, he said investors still do not know why that cycle peaked at a specific point in time, making it challenging to forecast when the current AI cycle could lose momentum.

This is an edited transcript of the interview.Q: The developments that are taking place in the talks in Switzerland between the US and Iran - irrespective of the directions that they're taking, or the short swerves on either side in a short span of time, the price of commodities and the markets tell you that it's not going to escalate much from here on. Would you be in that camp as well? And were that to happen, do you think it's a case for emerging markets to start outperforming once again?

A: It's so difficult to put any odds on these negotiations. They will be successful because I sense the tone from the Trump administration is that they want the MoU to become a permanent thing. But it's very hard to stop the fighting in Lebanon, especially when there's an election in Israel later this year, and all of the parties in Israel, frankly, need to show that they're very tough.

So, I would like to think it will hold, and if it does, then the oil price should continue to go down. That is our view. Our forecast is $60 a barrel this time next year, and if that is correct, then I would think the emerging markets that are most sensitive to the oil price — and that, of course, includes India — would be the obvious beneficiaries.

Q: Are you investing, trading, and approaching the markets with war completely on the sidelines, such that it's not a part of the investing approach? Or is it a part of the way you're constructing your portfolio right now and incrementally investing money? And if yes, could you explain that?A: We hope and think that the memorandum of understanding will stick, the Strait of Hormuz will reopen, and the oil price will go down. But I can't put a probability on it. So, I would simply say that the conflict in West Asia, if it does go away, will give us a sugar rush in markets and ultimately take all of them quite a bit higher. If it doesn't go away, I think that, ironically, markets are managing to survive just fine.

The pain point in the United States for oil to hurt the economy and stock market is way above where the price got to, which was about $115 per barrel at its peak in April. It needs to be north of $150 per barrel, maybe even closer to $200 per barrel, to have a serious impact on the US economy. Of course, for countries like India, the pain point is much lower. It's probably around $90 a barrel. So, if this memorandum of understanding sticks, then India is looking better.

Q: You said that India could actually do well. Do you think India could actually outperform? Because we have been ranked as underperformers. You see it from the start of this war as well. Equity markets have been holding up, as you said. Do you think there's a case for India to outperform? And given the kind of flows that we've seen — outflows from India for the first five months of the year — do you think there's a case that FIIs gradually come back? Because now the rupee is showing signs of stability, crude oil prices have cooled off, and hopefully, we get back to our growth as well as earnings growth.A: Yes, the crude oil price coming down is, of course, a positive. Also, the RBI is making it more attractive for non-resident Indians to have fixed deposits in India, and the government is getting rid of taxes on foreigners investing in fixed income in India — all of those are good things. But ultimately, I think the problem is that earnings growth in the United States is so strong. It's probably going to be around 20% this year and high double digits next year as well. India can't match that because it doesn't have this big AI-driven earnings cycle that the US does.

What I would say is that when the AI bull market eventually peaks and rolls over, then I'm sure money will want to come back to India. The thing is that we just don't know when that is. Even today, nobody knows why the dot-com bull market peaked in March 2000. Why wasn't it in March 1999, or March 2001, or 2002? We don't know. So, trying to put a top on this AI bull market is next to impossible. But it is still very much alive, and as long as it remains alive, India is not on the radar screen of global investors.

Q: A quick word with regard to what you heard from the new Fed chair, Kevin Warsh, last week. He sounded a little bit hawkish, according to most market participants. And now we are factoring in a rate hike. What did you make of the comments out there? Do you think that could be a bit of a spooky factor that plays out in the latter part of this year? We have the crucial PCE data as well, which is expected on Thursday this week.A: I don't think he's a hawk at all. In fact, he wants to let the economy run. He doesn't want to raise rates. The historical precedent he looks at is exactly the one I just talked about, which was the late 1990s. From 1996 to 1999, Alan Greenspan did not raise interest rates, even though there was a big productivity boom driven by the Internet. It was the right decision not to raise interest rates because the productivity-driven internet boom did not cause inflation.

Warsh is on record as thinking that the same applies today, and he said even last fall that it would be a mistake to raise rates because of this AI productivity expansion.

So, I don't think they're going to raise rates and the dot plot he did not contribute to, he's also on record as saying that he thinks it provides false guidance because it's basically a signal that the Fed thinks rates are going to go a certain way. But its track record is no better than that of economists on Wall Street. So, he feels that it provides some false guidance, and he'd like to get rid of it.

Q: Just to go back to your point on trying to call an AI top — now it's impossible, like you said — but I'm sure from the earlier runs that we saw in the market, or thematic runs, there were signs when we were nearing the top. What could those be when we're looking at the current cycle?A: The most obvious one is the price-to-earnings ratio of the big technology stocks. At the peak of the dot-com bubble, the big five technology stocks were trading at over 50 times earnings. Today, the Magnificent Seven are in the mid-20s on a price-to-earnings basis.

So, I don't think we can make a case for an extremely overvalued market in the United States. You might be able to make that case in some other parts of the stock market, where there have been smaller AI plays that are extremely expensive, or SpaceX, obviously, and some of these big AI IPOs that are coming up, too. But for the broader S&P 500 and the big technology stocks in it, you cannot call it an expensive market.

For the full interview, watch the accompanying videoCatch all the latest updates from the stock market here