MARKET PULSE – 25 JANUARY 2012
RBI signals shift into growth supportive monetary stance
RBI chose to go against consensus to kick start the reversal of monetary stance from hawkish to dovish with a very short pause phase. RBI also revised its growth and inflation estimates to 7% for FY12; same as our projections that we were highlighting in our reports for growth and inflation meeting around 7% to enable RBI to dilute its anti-inflation monetary stance. It was also mentioned that it is critical and important to arrest slippage in growth momentum below 7% with greater comfort on headline inflation print below 7% on shift into FY13. The priorities into the policy review were many in a complex economic and market environment. Most important of these were liquidity management and creating favourable domestic environment that will help the Government in addressing issues related to fiscal deficit. RBI has flagged weak rupee and high fiscal deficit as major risk to inflation and it would need shift into higher growth momentum to address fiscal deficit through higher revenues. It is also essential to raise investor confidence (and appetite) for smooth completion of disinvestment plans. The delivery of 50 bps CRR cut may not change the rate/yield dynamics immediately but RBI’s shift of stance from anti-inflation to pro-growth will get the investors to “risk-on” mode. There was need for looking at alternate avenues for liquidity injection other than OMO purchases and RBI has no option but to take out the CRR tool. A rate cut at this stage may not be relevant given the overnight MIBOR trading at 50-75 bps above Repo rate but there is confirmation of trigger of rate actions in due course. Over all, RBI has done its best to maintain the optimism generated since start of 2012. The immediate beneficiary is the equity market while it is matter of time for short term money market rates to start trending down to effect pass through into deposit and lending rates. Bond market has taken the worst hit on fear of reduced OMO operations. It is now seen that liquidity injection will be done through CRR cuts and interventions in the FX spot/forward market. 10Y bond yield fell sharply from 8.08% to 8.37%; one of the worst post-policy weakness in Bond market. In hindsight, post-policy price volatility could have been avoided with a combination of 50 bps CRR cut and 25 bps rate cut which would have given price stability in 10Y Bond at 8.0-8.25%. There is nothing to panic at this stage as market will prepare for next round of actions in mid March 2012. The take-away is that the next action will be on rates or in combination of both; hence it is the time to stay invested in Bond and equity markets.
Bond/OIS market
10Y bond yield traded end-to-end of 8.10-8.20% range; pre-policy weakness into 8.21% (on 23rd January) attracted good interest and post-policy rally into 8.08% lost steam quickly for sharp reversal into 8.37% before close at 8.35%. It is a worry that despite RBI delivering “pleasant surprise”, market closed weak. The fear of RBI reducing its OMO operation caused panic to drive the 10Y bond yield into 8.35%. The “fear” is valid given the huge pipe-line supplies through rest of FY12 and into FY13. But given the tight liquidity situation, RBI is expected to continue its OMO operation through FY12. Having said this, it should also be noted that RBI has options to infuse liquidity through FX market; purchase of spot dollars and/or through Buy/Sell swaps in the forward market. Over all it is possible that till RBI gets into rate cut mode, extended gains below 8.20% is not sustainable for consolidation within 8.20-8.35% into near/short term. Given the expectation of move of operative policy rate into 7.5% by end July 2012, revisit to 8.10-8.0% is not far away. It is good for strategic investors to absorb extended weakness into 8.35-8.45%. Let us now watch 8.30-8.40% with overshoot limited to 8.25-8.45%. Strategy is to stay invested for 8.20%.
OIS rates moved up sharply into 8.06% (1Y) and 7.37% (5Y) tracking weakness in the bond market for close at 8.03% and 7.35% respectively. The market is now back into the set receive zone of 8.05-8.10% (1Y) and 7.30-7.35% (5Y) after providing shallow correction of 10-15 bps. Here again, there is no reason to chase rally beyond set higher end and it is important for 10Y bond yield to hold on to its weakness below 8.40% to prevent extended rally in 5Y OIS rate above 7.40% triggered by bond-swap deals. While it is safe to hold to 1Y OIS book at 8.05-8.10%, we need to stay cautious on 5Y rate spike above 7.40%. Now we watch consolidation in 1Y at 7.95-8.10% and 5Y at 7.30-7.40% with test/break either-way to attract. It would need benchmark overnight MIBOR to ease into Repo rate to provide bit of relief and expectation of rate cut in mid March 2012 will generate momentum for reversal.
Currency market
Rupee continues to maintain its bullish stance to post a high of 49.92 before close at 50.10. In the process, January 2012 dollars hit a low of 49.97 (into the set buy zone of 50.05-49.95) and April 2012 dollars fell to a low of 51.03 from our sell entry at 51.60-51.75. What next? Despite shift into soft interest rate regime, rupee bulls are firmly in control of the street. Good FII flows and high FX premium will continue to keep the market in supply driven mode while rupee bulls need to have close watch on RBI on its shift of stance from USD sell mode to buy mode. RBI may chose to intervene in the forward market through Buy/Sell swaps rather than outright dollar purchases in the spot market. In the given bullish market dynamics, it is possible that rupee has shifted into a 49-51 short term range. This makes March 2012 dollars attractive around 51.00; thus limiting spot rupee weakness at 50.25-50.35. On the other hand, USD Index should find solid support at 79.50-79.30 for rally back into 81.50. This expectation should make February 2012 dollars attractive around 50 to limit spot rupee gains beyond 49.60. Taking all these together, let us watch near term consolidation at 49.75-50.25 with overshoot limited to 49.60-50.40. The near term strategy is to sell March 2012 dollars at 51.00-51.15 and to buy February 2012 dollars at 50.00-49.85; it is difficult to take a view beyond there as we await more cues for the next direction.
EUR/USD found support on entry into the set buy zone of 1.2875-1.2825 (low of 1.2869) for sharp move into sell zone of 1.3075-1.3150 (high of 1.3062). The reversal from there found support above 1.2950 (low of 1.2952) and now at 1.3025. EUR/USD is in consolidation mode at 1.2900-1.3100 with overshoot limited to 1.2850-1.3150. There are no strong factors at this stage to look for extended rally beyond 1.3150; higher end of set near term range of 1.2650-1.3150. Let us now play end-to-end of 1.2900-1.3100 and stay short at 1.3100-1.3150 for reversal back into 1.2650-1.2500. In the meanwhile USD/JPY has bounced from close to 76.75 to take out the strong resistance at 77.25-77.35 into 77.75-78.00 (high of 77.81) driven by EUR/JPY rally above 100. We had highlighted this as risk factor that EUR/JPY below 100 will cut downward momentum on USD/JPY for sharp reversal. It is now possible that the USD/JPY rally that we were discussing from 76.50-75.50 has begun from the low of 76.54 and those who shifted USD liability into JPY there would stand to gain into the short term. Now, we watch 77.25-78.25 and prefer build up of momentum for extension into 80 in due course.
FX premium eased nicely from 9% in 3M and 6% in 12M but found support above 8% and 5.5% respectively before close at 8.7% and 6% respectively. No change in view as we look for two-way consolidation at 8.0-9.0% in 3M and 5.5-6.0% in 12M. There is strong support from exchange rate play driven by rupee strength while would need ease in short term money market rates to add momentum to the reversal. The uptrend in premium despite RBI shift into dovish monetary policy stance can bring RBI into Buy/Sell mode for twin objectives of infusing rupee liquidity and to cut FX impact on MM rates. It is important to drive credit demand from rupees into dollars to release pressure on rupee liquidity. The high premium in 1-3M tenors is causing shift of rupee funds into nostro accounts which needs to be cut. But this has the risk of driving the USD/INR up into 51.00; hence the need to balance the dynamics between weak rupee and tight rupee liquidity. While RBI is working overtime to balance growth-inflation dynamics, now a new dimension has emerged to balance rupee liquidity-weak rupee dynamics through its presence in the FX swap market.
Commodity market
Gold lost steam at the higher end of 1630-1680 range (high of 1681); thus completing end-to-end of this range from recent low of 1630.94 and now trading around 1665. Gold has maintained its bullish momentum while dollar has given up its recent gains. There are no factors at this stage to look for extended rally into 1700 but it is possible that reversal from now will find good support around 1650 ahead of 1630. Let us now watch consolidation at 1650-1680 with overshoot limited to 1630-1700.
NYMEX crude found solid support at 98.00-97.50 (low of 97.40) for reversal into sell zone of 99.50-100.50 (high of 100.18) and now trading around 99.00. Let us continue to watch consolidation at 97.50-100.50 with overshoot limited to 95-103. We may need to maintain neutral stance on directional break-out.
NIFTY
NIFTY held just above our first buy zone of 5000-4975 (low of 5021) and rose sharply into 5141 before close at 5127. The market sentiment is looking good from positive domestic cues and good FII interest for gradual move into the immediate pit stop at 5350. It is matter of time before domestic institutional investors step in to provide the desired momentum. We now revise the near term range at 5000-5500 with bias into higher end. Strategic investors can hold on to long entered at 4550 with trail stop below 5050 while fleet footed traders can look to buy in two lots at 5100-5075 and 5050-5025 with stop below 5000 for 5350-5500.
Moses Harding
