Low confidence level on macro fundamentals; shift to neutral stance
RBI has turned cautiously bearish on macro economic outlook. There is lack of confidence on favourable trending in key parameters of growth; inflation; fiscal deficit; commodity prices; trade deficit; exchange rate etc. This will lead to serious erosion in investor and consumer confidence into the Indian economy and markets. The ability of the Government to roll-out economic reforms or roll-back costs for fiscal consolidation is in serious doubt given the conflicts within UPA coalition. It is possible that foreign investors will get into wait-and-watch mode and may tend to trim positions. The build up of bullish expectations in the US zone may attract foreign investors; risk of reverse flow of funds or lower allocation to Indian markets. Now, mid quarter review of monetary policy is out of the way with disappointment; post-policy weakness across stock, bond and currency market says it all. Nothing significant is expected from the Union Budget and the risk of general election ahead of schedule has set in. It is prudent for investors to lock in to high yield fixed income assets till emergence of clarity on the way forward. It is good to preserve capital with not-so-bad return from fixed income at rates 11.5-12% for 3-6M tenor. India Inc is getting into a vicious trap – high inflation is detrimental to growth but low growth (with high cost subsidisation) is bad for inflation. The solution is to address second generation reforms in the budget to attract foreign capital and ensure flow of adequate domestic capital and liquidity to high growth centric sectors; delivery of populist budget with eyes on vote bank and coalition partners will be harmful at this stage to make things worse both on growth and inflation. Can the FM act bold and build consensus within UPA coalition? If FM can succeed, it would be a good sign for the way forward. Else, it would be tough to balance expectations on growth and inflation. What is the impact on asset markets in the short term?
Fixed Income (Bonds/OIS)
Money market rates are already at its peak with 1-3M rate at 12.0-12.5% and 6-12M rate at 10.75-11.25%. The draw down from LAF counter is at the higher end of expected Rs.1.0-1.5 Trillion for the week. This scenario is seen temporary till end of March and would see sharp reversal in money market rates with deficit system liquidity down at RBI’s comfort level of 1% of NDTL (at Rs.50-75K Crores). This is the time to stay invested for 6-12M tenor. Bond market will be in consolidation mode till April 2012 annual policy review with 1Y bond yield at 8.40-8.50% and 10Y bond yield at 8.25-8.50%. While it is good to stay invested in 1Y on weakness into 8.5%, it is prudent to trade end-to-end in 10Y bond; there will be no momentum for conclusive break-out either-way. 1Y OIS rate is back into 8.10-8.25% while 5Y rate is up at 7.45-7.70%. It is better to stay away on the 1Y and trade end-to-end in the 5Y; test/break either-way would lose momentum. It is good to get into 1X5 play by receiving 1Y at 8.25% and paying 5Y at 7.50-7.45%. Over all, RBI has supported growth (at cost of inflation) by pumping over Rs.3 Trillion of liquidity (through CRR cut; OMO and LAF); the Government needs to act with measures that would provide downtrend in inflation without compromise on fiscal deficit which then would trigger rate reversal cycle from RBI.
Equity market
The post-policy reversal found support above 5350 (low of 5362) before close of day at 5380. The domestic investor appetite is expected to be low while FII flows will dry up with risk of reverse flow on bearish cues in the Budget. Now, the focus is back into the lower end of the set near term range of 5200-5500 with risk of extended weakness into 5000 on bearish cues from the Budget. It may not be a one-way run given the bullish western markets with DJIA expected to form a strong base above 13000 for extended gains into 13800-14000. It is prudent for strategic investors to exit investments (for shift into short term fixed income assets) and stay away from equity assets for now. Let us watch price action (and the momentum) on move into 5200-5175 considered as strong base for bullish reversal. It is possible that NIFTY will be in consolidation mode at 5000-5500 till RBI’s shift into growth supportive monetary stance.
Currency market
USD/INR held well at the lower end of set near term range of 49.80-50.80 and moved sharply up from the low of 49.82 (buy zone of 49.85-49.75) to 50.49 (t/p zone of 50.40-50.50) before close of day at 50.38. In the process, it also triggered the December 2012 sell orders above 53.00 (high at 53.09). The (post policy) bearish set up on rupee is strong on fear of dilution in FII flows in the near term. NRI flows are also expected to be low on down trend in money market rates on shift into FY13. What next? Having traded end-to-end of set near term range of 49.80-50.50 in two trading days, the trading range now is shifted to 50.15-50.65 with overshoot limited to 50.00-50.80. There is no risk of extended weakness beyond 51 at this stage; it is considered good to sell 1M dollars above 51 (spot at 50.60-50.70) and June 2012 dollars above 52 (spot at 50.85-50.95). These actions will prevent extended rupee weakness beyond 51. It is important for importers to stay hedged on 1-2M payables on spot correction into 50.15-50.00 and 49.85-49.70. Those who are already covered on recent spot move into 48.85-48.60 can stay relaxed and not to chase this weakness. Over all, we watch consolidation at 50-51 with test/break either-way seen as excessive and await fresh cues to provide guidance for range break-out.
There is no change in FX premium outlook for consolidation in 3M at 8.0-8.75% and 6.0-6.5% in 12M. It is prudent to play end-to-end of these ranges as test/break either-way is not expected to sustain. It is good to receive June 2012 at 8.5-8.75% for ALM play (to fund PCFC book of L+3.5%) and to pay 12M below 6% for conversion of FC sources into rupee uses. There will be good arbitrage on these carry trades. It would need extended rupee weakness beyond 51 to drive premium down; very low probability at this stage. Strategic players can look to receive 12M at 6.50-6.65% and pay at 6.0-5.85%.
G3 currencies have now traded to the script completing end-to-end of set near term ranges. USD Index is up from 78.20 (low of 78.10) to 80.50 (high of 80.73); EUR/USD is down from 1.35 (high of 1.3485) to 1.30 (low of 1.3002); USD/JPY up from 80 (low of 79.99) to 84 (high of 84.17) and EUR/JPY up from 105.50 (low of 105.62) to 110 (high of 109.63). What next? We advised to shift USD liability to JPY liability at 76.50-75.50; since then, JPY is down to 84 by more than 10% in less than 2 months. Let us not chase JPY weakness beyond 85.00-85.50 and would consider this zone as good to shift JPY liability back to USD. EUR/USD is now into 1.27-1.32 near term range with bias into lower end while USD/JPY is expected to stay in sideways trading mode at 82.50-85.50. Let us play end-to-end of these ranges with test/break either-way to lose momentum. There is big trade waiting in EUR/JPY considered good for 500 pips. It could be a sharp reversal anywhere from 110.00-111.50 for push back to 106.50-105.00; keep a close watch there.
Commodity market
The reversal in Gold found support at 1635 but bounce from there into 1665 is strong. The recent test/break of above 1700 into 1715 could only result in build up of strong momentum to take out strong support at 1665 for extension into 1635. The strong USD and uptrend in US interest rates will arrest bullish trend in Gold. Let us watch 1615-1685 with overshoot to stay limited to 1600-1700. The downtrend in US interest rates and release of QE3 by FED is essential to get the bullish momentum back on Gold. Else, the focus will shift to 1520. Strategic investors can play end-to-end by selling at 1685-1700 and buying at 1615-1600 with tight affordable stop.
NYMEX Crude is boxed at 105-108 range with no momentum to provide conclusive test/break either-way. There is no change in view and prefer near/short term consolidation at 103-108 with overshoot limited to 100-110. The short term bias is in favour of reversal into 95 while any rally into 110 will attract intervention fears through release of supplies from strategic reserves. Strategic players can sell rally into 108-110 with tight stop for 100 and further extension into 95.
It has been a hectic week; have a great weekend.........................Moses Harding
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