MARKET PULSE: Weekly report for 26-30 March 2012
RBI into act of compromise to prevent hard landing of Indian economy
We are into the last lap of FY12 and Indian economy (and its asset markets) is beaten down badly in the second half of this financial year. The first half was rather smooth; the trigger for reversal since July 2011 was from the Euro zone on which the authorities had little control. But for the aggressive OMO bond purchases and FX intervention (and related strictures) by RBI and aggressive liquidity injection in the Euro zone through QE/LTRO, the situation would have been worse. Since then, Indian economy has got into vicious trap with all kinds of woes such as low growth; high inflation; high fiscal deficit; high trade deficit; weak rupee; high crude oil price; high cost of subsidy; lack of investor confidence; weak consumer sentiment; low economic productivity and low efficiency. The list is big and there is conflict of interest in addressing these issues. There has to be compromise to protect some with little damage to others. It is impossible to tackle all these woes at the same time. The asset markets are under pressure post-budget with little optimism on the way forward without monetary support from RBI. Stock, Bond and Rupee values are down and weak. In hindsight, things would have been better had RBI delivered 25-50 bps rate cut on 15th March ahead of release of Budget FY13. The prioritisation to get the Indian economy out of the woods has to be on growth and fiscal consolidation. RBI will be under obligation (and “pressure”) to shift into easy liquidity and moderate interest rate monetary policy regime without getting into aggressive rate reversal cycle. Let us set the road map for FY13 with the belief that RBI will remain supportive to the Government in its efforts to achieve the set budgetary target for FY13 on the most critical parameters of growth at 7.6%; fiscal deficit at 5.1% and cost subsidisation at below 2% of GDP. It will be extremely difficult for the Government to achieve these numbers without the magnanimity of RBI; to get into act of compromise by releasing its grip on monetary policy.
It is possible that RBI may not like to deliver more than 50 bps rate cut during FY13 for shift of LAF corridor to 7.0-8.0% from current 7.5-8.5%. This is considered as a moderate stance on interest rate. The cut in policy rates is expected to be in 2 phases of 25 bps each in April annual review and June mid quarter review or in one-shot before end of June quarter of FY13. The downward shift in operative policy rate from 8.5% to 8.0% before end of June 2012 will provide good relief to the FM. Beyond there, next phase of compromise for shift of operative policy rate from Repo rate to Reverse Repo rate through injection of primary cash (CRR cuts and OMO) will be linked to key deliverables of setting downtrend in core inflation; continued pressure on growth momentum; extent of pass-through of subsidy and Q1 revenue collections. RBI will also monitor impact of crude oil price and rupee exchange rate on headline inflation and cost subsidisation. If all goes well, we can expect shift of operative policy rate from 8% to 7% by end of Q2 ahead of move into busy season. It would not be fair (and prudent) to expect beyond this in FY13. RBI’s concern on real inflation after adjustment of cost subsidisation will limit extension of compromise support beyond these two phases of monetary actions. It would need sharp fall in headline inflation below 4% (real inflation at 6-6.5%) to push RBI into the next phase of delivery of more rate cuts; considered wishful at this stage. So, let us stay prepared for two rounds of actions from RBI; 50 bps rate cut in Q1 and shift of operative policy rate to the lower end of LAF corridor in Q2. This stance will provide price stability across all asset markets in FY13 without getting into a bullish or bearish trend.
Fixed Income market
Let us get into Q1/FY13 outlook as most market participants would have closed books for financial year end. The liquidity (and cost of liquidity) continues to stay tight (and high) but expected to ease by second week of April. It would be with the combination of release of cash by the Government and reduced demand from the banking system having shifted into new financial year. The draw down from LAF counter (on fortnight average basis) is expected to fall to Rs.50-75K Crores by middle of April within RBI’s comfort zone of 1% of NDTL. Banks are already in excess SLR mode to the tune of 3-4% of NDTL and pick-up in credit demand will result in these funds being used for productive purpose. It is also considered inefficient if RBI provides funding through LAF counter for excess SLR investments on regular basis. This round tripping exercise impacts Banks’ NII; client deposits (at cost above 10%) are used to fund investments (yielding sub 8.5%) which in turn refinanced at 8.5%. If not refinanced in full; high cost bank deposits are invested in low yielding SLR investments. There will be sharp downward shift in money market rate curve irrespective of delivery of 25-50 bps rate cut in April review (17th April) with 1-3M rates at 9.0-9.5%; 3-6M rates at 9.5-10.0% and 6-12M rates at 10.0-10.5%. This shift in money market rate curve below Banks’ Base rate (on pre-stat cost basis) will be prerequisite to enable Banks to prepare for cut in lending rates on delivery of rate cut by RBI. For the week, average draw down from LAF counter will be over Rs.1.25 Trillion on higher demand in the first week of current reporting fortnight cycle with pressure on overnight MIBOR into 9.5%. Let us not rule out extension beyond MSF rate of 9.5% into double-digit by close of week/financial year end. The shorter end of the money market rate curve will be high with 15-30 days rate at over 12%; 31-45 days at 11.5% and 46-90 days above 11%.
10Y bond found support at the higher end of set near term range of 8.35-8.45% (high of 8.45%) for gradual reversal into the lower end (low of 8.36%) before close of week at 8.38%. The immediate attention will be on FY12 IIP/WPI/GDP numbers and H1 borrowing calendar of RBI. The supply side concern is back into focus and it would need combination of OMOs and CRR cuts to drive the Bond market into consolidation phase. Given the expectation of best case scenario of operative policy rate at 8% latest by end of June (with lot of strings attached for further downtrend in Q2), it would not be prudent to expect rally in 10Y bond yield beyond 8.25%. On the other hand, weakness into 8.50-8.65% will be considered good to invest subject to improvement on factors considered as major risk to inflation. It would need 50-75 bps CRR cut and shift of operative policy rate from Repo to Reverse Repo rate (at 7%) to get the focus back into 8.10-8.0%. Let us keep this option valid in the event of sharp downtrend in inflation and continued pressure on growth. Over all, these factors set up short term range play in 10Y bond yield at 8.25-8.50% within 8.10-8.65%. The risk factor of extended weakness beyond 8.65% into 9.0% will be driven by high BRENT Crude (above $135) and weak rupee (above 53). On the shorter end, stay invested in 1Y bond at 8.40-8.50% for final objective below 8%. For the week, let us watch 10Y bond yield at 8.30-8.45% with test/break either-way not expected to sustain. Strategic players can look to exit 10Y bonds on extended gains into 8.30-8.25% (for shift into 1Y bond at 8.40-8.50%) and await 8.50-8.65% for re-entry. Fleet footed traders can looked to trade end-to-end by buying at 8.43-8.46% and selling at 8.32-8.29% with tight affordable stop.
1Y OIS rate nicely held at the door step of receive zone of 8.25-8.28% (high at 8.25%) for reversal into the lower end of set near term range of 8.10-8.25% (low at 8.11%) before close of week at 8.12%. On the 5Y OIS, rate eased from close to the higher end of set near term range of 7.55-7.65% (high of 7.64%) into the set pay zone of 7.55-7.50% (low of 7.50%) before close of week at 7.53%. Let us hold this 1Y OIS received at 8.25% and 5Y OIS paid at average 7.52% (with carry of 73 bps). The Q1 outlook on OIS is for downtrend in 1Y OIS below 7.90% (ahead of 7.65-7.50% in Q2) while 5Y OIS continue to stay in consolidation mode at 7.50-7.65% to squeeze the 1X5 spread close to par by Q3/FY13. The risk factor to this expectation will be on spike in 10Y bond yield above 8.65% which could trigger sharp spike in 5Y OIS rate into 8% while 1Y OIS rate stay steady around 8%. In either of the case, it is low risk; high reward trade to stay received in 1Y and paid in 5Y with positive carry of over 70 bps. For the week, let us watch consolidation in 1Y at 8.05-8.20% and 5Y at 7.50-7.65%. The strategy is to receive 1Y OIS at 8.20-8.25% and pay 5Y OIS paid at 7.50-7.45% (for minimum carry of 70 bps); spike in call money rate above 9.5% will keep the market bid for move into higher end of set ranges before reversal into the lower end on shift into FY13.
Currency market
The lack of optimism in FY13 Budget (and conflict of interest between the FM and Governor to manage growth-inflation dynamics/expectations) has triggered this strong bear run on rupee despite downtrend in USD Index and consolidation in stock market/crude oil price. The disappointments from RBI policy review and FM’s Budget coincided with strong month/financial year end demand for the greenback. The move from 49.80 to 50.80-50.90 was not a surprise but overshoot above 51 was not in the radar. Taking all these risk factors, had suggested importers to cover short term imports (up to end April 2012) on recent run into 48.85-48.60 (low of 48.60) and 49.80-65 (low of 49.79). Now, the strong bounce from there has made forward dollars attractive for exporters; December 2012 dollars above 53.65 and 12M dollars above 54.30 (recent high which triggered RBI’s aggressive action to push USD/INR down all the way into 48.60). It is also seen that 12M premium is getting adjusted to higher spot with not much of difference in 12M value of the dollar on extension in spot value from 50.90 to 51.20. What next? The immediate resistance is at 51.40-51.50 zone followed by 52.05-52.15 while 50.80-50.70 holds firm in the near term. There is no risk at this stage looking for extended weakness in spot rupee beyond 53.50 in 2012 or beyond 54.30 in FY13; hence rupee weakness from now on would be good to cover long term export receivables. It would not be in the interest of the Indian economy to get the focus back above 53 when RBI is expected to take growth-supportive stance. It is possible that USD/INR has shifted to a new range of 50-51 in the immediate term before shifting the focus back into 49-50. It was advised to avoid chasing rupee gains below 49.00 (into 48.60) with suggestion to cover short term imports; now it may not be prudent to chase rupee weakness beyond 51.00 (into 51.40) and would be good to cover January-March 2013 exports at 53.65-54.35. For the week, reduction in dollar demand and bunched up nostro supplies would provide relief to rupee. The concern will be from weak stock market but RBI’s shift into rate cut mode will provide stability. USD Index is expected to stay under pressure for test/break of 79.10-79.00 into 78.20. Over all, there will be significant dilution in the current bearish set up on rupee for shift into consolidation mode. Let us look for stability at 50.70-51.50 with bias into lower end (not ruling out extension into 50.30) while extended weakness into 51.50 will attract exporters’ interest and attention of RBI. It is important to get the short/medium term range into 49-51 for good of the Indian economy and its asset markets. The strategy is to stay cautiously “short” dollars on move into 51.40-51.50 (with stop above 51.60) for 50.70/50.30. The risk of extended weakness into 52.05-52.15 will be on USD Index rally above 80, considered now as a low risk factor. Over all, extended gains in rupee beyond 49 was considered good for importers and now believe extended weakness above 51 will be good for exporters.
The rally in FX premium halted at upper end of set ranges of 8.35-8.85% (3M) and 6.25-6.75% (12M) for sharp reversal from there for close at 8.6% in 3M and 6.3% in 12M. The trigger was strong exchange rate play driven by sharp spike in spot rupee into 51.20 from 50.75. The interest rate play continues to provide support but adjustment of over valuation of forward dollar (in the 9-12M tenors) was too strong. The interest rate play will stay valid on shift into last week of financial year and first week of new reporting fortnight cycle. It is also possible that spot rupee sets into reversal mode from below strong support at 51.40-51.50 (into 50.50-50.30). The traction now will be more with exchange rate play while staying neutral on interest rate play given the fact that money market rate will ease sharply on shift into FY13. For the week, let us watch 3M at 8.25-9.0% and 5.75-6.75% in 12M. We have already seen end-to-end moves within these ranges couple of times and it would need strong momentum for convincing break thereof. Strategic players who have received 3M at 8.75-9.0% (to fund PCFC book) can look to unwind this position on shift into FY13 when 3M premium is expected to get into consolidation mode at 7.0-8.0%. Traders who have received 12M at 6.75% or Mar/Feb at 308-313 can look to unwind at S/Feb move into 6.0-5.75%. Also, track 12M forward dollar at 54.40 to trade 12M premium (in alignment with spot value); most actions are expected to be in the longer end tracking spot rupee moves while high money market rates provide stability in the shorter end.
We could not have asked for more; G3 currencies traded to the script within the set ranges of 1.31-1.33 (EUR/USD); 81.75-84.25 (USD/JPY) and 108.50-111.50 (EUR/JPY). It first triggered our sell at 1.3275-1.3325 (high of 1.3293); 84.00-84.25 (high of 84.09) and 111.25-111.75 (high of 111.43) for sharp reversal to 1.3133; 81.97 and 108.46 respectively. The bounce from there has been sharp for weekly close at 1.3271; 82.31 and 109.27 respectively. What next? USD has lost its momentum with sharp reversal in USD Index below 80 (high of 79.95) into immediate support at 79.10 (low of 79.21) before close of week at 79.30. Now, the bias is for test/break of immediate support at 79.10 for quick extension into 78.10-78.00. This move has to be supported by Euro strength with USD/JPY pair looking weak. For the week, let us watch EUR/USD at 1.3175-1.3475 with bias for move into higher end to complete the end-to-end move within the set short term range of 1.30-1.35 (down from 1.3485 to 1.3002 and now back into 1.35). The trading strategy is to stay “long” for this move by buying at 1.3200-1.3150 (with stop below 1.3125) for 1.3475-1.3500. Fleet footed traders can look to sell at 1.3475-1.3500 (with stop reverse at 1.3525); break of 1.3475-1.3500 resistance will shift the focus into 1.3850-1.4000.
USD/JPY looks good for extended weakness below 81.75 into 80.50 before strong reversal. Over all, near term consolidation within 80-85 will be in order at this stage. For the week, let us watch 80.50-83.50 with initial bias into the lower end before sharp reversal into 84.00-84.25 and for further extension into 85.00-85.50. The trading strategy is to stay “short” by selling at 83.00-83.50 (with stop above 83.75) for 81.00-80.50. Let us also buy at 80.75-80.25 with stop below 80 for 85.00-85.50.
It was a good 300 pip trade (against 50 pip risk) in EUR/JPY from 111.50 to 108.50. The trend is down for immediate objective at 107.50 not ruling out extension into 105.64; trigger point for sharp rally into 111.43. For the week, let us watch 107.50-110.50 with bias into the lower end. The strategy is to reinstate “shorts” at 110.00-110.50 (with stop above 110.75) for 107.50-105.75. It is a good risk-reward trade with 50 pips on the table for 300-500 pips in the pocket.
Equity market
NIFTY lost momentum at the higher end of set weekly range of 5075-5400 (high of 5386) and in the process triggered our “sell” at 5325-5375; reversal from here held well at first support zone of 5200-5175 (low of 5205) before close of week at 5278. What next? In the absence of any positive take-away from either the pre quarter review of monetary policy or Budget FY13, set up of bearish mode in stock market was not a surprise and we turned “short” post-policy and pre-budget; since then NIFTY has reversed from 5445 to 5205, short of immediate objective at 5175. However, NIFTY is not expected to extend this bear run beyond 5080-4950 at this stage. It is possible that RBI gets into compromise mode to deliver 25 bps rate cut on 17th April which would trigger entry of domestic investors. The aggressive flows from FIIs since end December 2011 may not be there in the near term as they would watch conflict of interest between FM and RBI in managing growth-inflation dynamics. For the week, let us watch sideways trading mode at 5075-5400 with test/break either-way to attract. The trading strategy is to sell in two lots at 5350-5375 and 5425-5450 (with stop above 5475) for 5175-5075. Strategic investors can stay away to buy in two lots at 5075-5050 and 4975-4950 (with stop below 4925) for reversal into 5400-5500; over all, prefer short term consolidation at 5000-5500 in Q1 of FY13; unexpected delivery of 50 bps rate cut on 17th April will trigger extended gains into recent high of 5630, so need to stay invested for this move.
Commodity market
Gold traded to the script within the set weekly range 1635-1665 and overshoot attracting good interest (high of 1669 followed by low of 1627) before close of week at 1659. The short term trend continues to stay bearish for test/break of 1600 for quick extension into 1520 while 1690-1715 stays firm. The stability in USD Index at 79-80 is also keeping Gold in tight range but general weakness for the dollar can push Gold into the higher end of 1685-1700 before reversal. For the week, let us watch consolidation at 1635-1685 with bias into higher end, not ruling out extension into 1700. Strategic investors can look to “short” the Gold in two lots around 1685 and 1705 (with stop above 1715) for 1525. Fleet footed traders can look to stay “long” for this move by buying at 1635-1625 with tight stop for 1680-1690.
NYNEX crude is struck within the 105-108 range (low of 104.50 and high of 108.25) before close of week at 106.75. There is strong resistance at 108-110 where even bulls turn neutral but bears are unable to take control to provide strong reversal into 100. It is trading in neutral zone of 103-108 for long time now but has given good two-way opportunities for fleet footed traders.. For the week, let us continue to watch consolidation at 105-108 with overshoot limited to 103-110. The strategy remains the same to sell at 108-110 to buy back at 105-103 with tight affordable stop.
Have a great week ahead......................Moses Harding
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