Weekly report for 23-27 April 2012

MARKET PULSE for the week 23-27 April 2012

The worst is behind for Indian economy but no great optimism into the future

The key events (of FY13) Union Budget and Annual monetary policy are out of the way. There are no concrete solutions in the Union Budget to get the economy back on track; shift back to over 9% growth momentum is now many years away. There is no political strength to roll-out reforms to attract long term foreign capital (and liquidity) into India; now pushed beyond 2014 elections. The financial position is weak, struggling to make both ends meet; continue to borrow for basic consumption. The set targets of GDP growth at 7.6% and fiscal deficit of 5.1% are seen as ambitious. The importance of monetary support for economic revival is seen critical at this stage. RBI has reversed its monetary stance in three phases: first, shift to neutral stance in December 2011, then addressed liquidity constraints through aggressive 125 bps CRR cut and now has cut policy rates by 50 bps to set downward trend in lending rates. There seems to be no quick-fix solutions to address issues relating to fiscal deficit; current account/trade deficit and prevent slippage in growth and inflation targets. The solutions have to be lead through increased investments and capacity expansion. It is important to create positive (and conducive) environment to attract domestic and off-shore investments and to expand economic capacity. The expected optimism would surface on roll-out of next generation economic reforms; expansion of capacity through public and private demand and adequate system liquidity and low interest rates. Indian currency continues to depend on off-shore flows (and hot money FII flows); Government needs to do more to increase the foreign investor confidence and given the rupee impact on inflation, the issue is really serious. Over all, capability to address these complex issues is limited; hence very little optimism into the future.

Interest rate market

RBI delivered to MARKET PULSE expectations and resultant post-policy rally hit the set objectives of 8.10% (1Y T-bill) and 7.85% (1Y OIS) to provide exit for “long” positions entered at 8.50-8.65% and 8.15-8.25% before close of week at 8.12% and 7.96% respectively. On the longer end, 10Y bond rallied into sell zone of 8.35-8.20% (low of 8.30%) and sharply reversed into the buy zone of 8.50-8.65% (high of 8.55%) before close of week at 8.54%. 5Y OIS failed to hold below lower end of set range of 7.45-7.60% for sharp reversal from 7.42% for close of week at 7.59%. We advised not to stay invested in 10Y bond at yield below 8.35% and not to stay received in 5Y OIS below 7.50%. RBI’s guidance on the way forward was more or less in line with our expectations of limited chances of rate cut and next major trigger will be through shift of operative policy rate from Repo rate to R/R rate. The shift of system liquidity from deficit to surplus is considered essential to address critical issues of attracting investment and capacity expansion. The pleasant surprise was from increase in MSF limit from 1% to 2% of SLR; ideally Banks can tap MSF counter at 9% and limit deposit acquisition at rates above 9%. Availability of refinance at 8% against excess SLR and at 9% against 2% of SLR will exert downward pressure on deposit rates which is essential for Banks to cut lending rates. What next? System liquidity position is not yet into RBI’s comfort zone but money market rates are sharply down with 3-12M CD rate curve at 9.0-9.60%. There will be liquidity squeeze on RBI’s intervention in FX market. Over all, system liquidity position is still tight and would need more CRR cuts to keep the deficit below RBI’s comfort zone. For the week, let us watch overnight MIBOR at 8.25-8.40%; 1Y T-bill yield at 8.10-8.20% and 1Y OIS rate at 7.85-8.0% and test/break either-way not expected to sustain.

We had set short term range of 10Y bond at 8.20-8.65% and considered good to unwind investments on extended gains into 8.35-8.20% and good to invest on weakness into 8.50-8.65%. 10Y Bond has now traded end-to-end from 8.30% to 8.55%. Bond market is neutral to bearish given the huge pipe-line supplies and it is important to drive the system liquidity from deficit to surplus or continue with OMO bond purchases to prevent extended weakness beyond 8.65% into recent high of 8.79%. On the other hand, it is very difficult for 5Y OIS to sustain below 7.50% with strong resistance at 7.65% subject to 10Y bond yield holding below 8.65%. For the week, let us watch 10Y bond yield at 8.45-8.60% with overshoot limited to 8.35-8.65% and 5Y OIS rate at 7.50-7.65% with test/break either-way not expected to sustain. The strategy is to stay invested in 10Y bond on extended weakness into 8.60-8.65% and trade end-to-end of the set range in 5Y OIS.

FX premium traded to the script; first moved into t/p zone of 7.15-7.0% (3M) and 5.80-5.75% (12M) and recovered sharply for weekly close at 7.6% and 6.05% respectively. There is no change in view of looking for consolidation at 7.0-8.0% in 3M and 5.75-6.25% in 12M. It would need next round of monetary actions to drive premium below the set lower ends. There is no risk of test/break higher at this stage given downtrend in domestic money market rates. However, exchange rate play is likely to exert upward pressure given the need to maintain premium to maintain forward market in dollar supply driven mode. For the week, let us watch 3M at 7.25-8.0% and 12M at 5.85-6.35%. The strategy is to receive 3M at 7.85-8.0% and pay 12M at 5.85-5.75%.

Currency market

The 52.05-52.20 zone seen as the worst case scenario for rupee is already hit with low of 52.20 before close of week at 52.07. The concern is from extended rupee weakness despite USD Index reversal from above 80 (high of 80.17) to 79.10. USD/INR lost its traction with USD Index triggered by concerns from widening trade/current account deficit. The retrospect tax impact and lack of clarity in GAAR has put FIIs in wait-and-watch mode and oil PSUs bulldozed into the market at the wrong time when dollar supply was scarce. Rupee exchange rate stability is dependent on sustainable capital account flows. Current Account deficit is a structural issue and it would take years (or decades) to get this right. Till then, we need to keep off-shore appetite intact and cannot afford to send negative vibes into them. Now, it is important for RBI to protect 52.40-52.50 to avoid getting the focus back into 53.05-53.15 ahead of 16^th December 2011 low of 54.30. The reversal in USD Index from above 80 is great relief for rupee bulls and possibility of further extension into 78.60-78.10 provides greater comfort. The Government has done its part to cut dollar demand from Bullion and precious metals. RBI has now the task of controlling demand from oil imports with the agenda to keep oil demand out when spot market is in dollar demand driven mode and to push cover when there is excess dollar supplies. RBI is also expected to supply dollars to prevent extended weakness of rupee with intent to cut its impact on inflation. For the week, let us watch 51.45-52.45 and would prefer gradual move into lower end. It would need aggressive FII flows to get the focus back into 50.80-49.95; not ruled out on clarification on GAAR. The strategy is to cover December 2012-March 2013 export receivables on spot weakness into 52.45-53.05.

EUR/USD held well at set strong support zone of 1.3025-1.2975 (low of 1.2993) for sharp reversal to retain the set near term play within 1.30-1.33 (high of 1.3226) before close of week at 1.3221. Given the mixed cues from US and Euro zones, EUR/USD seems to retain its consolidation mode at 1.30-1.35 with high of 1.3486 and low of 1.2993. For the week, let us watch 1.3125-1.3375 with overshoot limited to 1.30-1.35; initial bias is for move into 1.3385 not ruling out extended gains into 1.3486 before reversal. The strategy is to stay “long” for this move while 1.3125-1.3100 is expected to hold; if not, should stay above 1.3025-1.2975.

USD/JPY held well at support zone of 80.50-80.00 (low of 80.31) and reversal from there held at resistance zone of 81.75-82.00 (high of 81.77) before close of week at 81.54. USD/JPY is now seen to retain its consolidation mode within 80-85 with no strong momentum to provide sustainable break either-way. For the week, let us watch 81-83 with overshoot limited to 80.50-83.50; initial bias is for break of immediate resistance at 81.75-82.00 for further extension into 82.75-83.25 which is expected to hold. The strategy is to stay “long” for this move while 81.00 stays firm; if not, should stay above 80.50-80.25.

EUR/JPY reversal from 107.07 held at 104.61 for sharp reversal into 107.80, thus setting up 250-300 pip trade (both ways) within 104.50-107.50; movement of EUR/USD and USD/JPY in the same direction providing excessive volatility. For the week, the focus shifts to consolidation within 106-109. Given the strong upward momentum both in EUR/USD and USD/JPY, extended gains into 111.25-111.50 is not ruled out. The strategy is to stay “long” for this move while 106.50-106.00 stays firm.

Equity market

NIFTY traded end-to-end of set weekly range of 5175-5375 (low of 5183 and high of 5342) before close of week at 5290. In the meanwhile DJIA rallied from 12850 to 13131 before close of week at 13029. The market is now marginally in favour of the bulls with formation of strong base in NIFTY at 5175-5125 and 12750-12700 in DJIA with near term objectives at 5625 and 13300 respectively. The market is yet to factor the aggressive stance of RBI and clarity on tax related issues should bring FII flows with attractive exchange rate. Despite macro issues, worst seems to be already behind and it is matter of time before optimism sets in to attract domestic investors. For the week, let us watch 5225-5450 with overshoot limited to 5175-5500. The strategy is to hold on to “long entered at 5200-5185; add at 5225-5175 for 5500-5625.

Commodity market

Gold is in consolidation mode in the “inner ring” of 1630-1660 within near term range of 1615-1685. There are signs of build-up of momentum for reversal into 1615-1600 while 1660 stays firm. The strategy for the week is to trade from “short” side for eventual break below 1600.

NYMEX crude lost steam at the higher end of set near term range of 101-105 (high of 105.07) for sharp reversal into 101.67 before close of week at 103.05. The undertone is neutral but inability to break below 100 and repeated knock at 105 is considered mildly bullish into near term to bring the focus into 108-110. But there is no danger at this stage to look for extended rally beyond 110; thus setting up short term consolidation at 100-110. For the week, let us watch 102-108 with test/break either-way not expected to sustain. The strategy is to trade end-to-end by buying at 102.50-101.50 and selling at 107.50-108.50.

Have a great week ahead....................Moses Harding      

Weekly report for 16-20 April 2012

MARKET PULSE for the week 16-20 April 2012

Monetary Policy expectations (major indicators):

CRR/SLR unchanged

50 bps cut in Repo/Reverse Repo rate

Growth projection at 7.5% with downward bias

Inflation projection at 6.5% with neutral bias (linked to crude oil and rupee behaviour)

Credit growth projection at 14-16% with downward bias

Deposit growth projection at 16-18% with downward bias

There is no serious concern on liquidity; deficit system liquidity (on reporting fortnightly average basis) is now around RBI’s comfort level of 1% of NDTL; probability of CRR cut is low, having delivered 125 bps cut (primary cash infusion of Rs.1.6 Trillion) since January 2012. The focus will now shift to cost of liquidity to enable Banks to cut lending rates. The other agenda is to support Government in its efforts to achieve FY13 GDP growth target of 7.6% and arrest fiscal slippage in FY13 beyond 5.1% target; most stake holders are not optimistic on achieving these targets without monetary support.  It would need shift into adequate (or surplus) system liquidity at affordable cost to achieve the set FY13 targets. A token rate cut (of 25 bps) may not help at this stage. If RBI has to endorse (or concur) with Governments’ FY13 target of 7.6% GDP and 5.1% fiscal deficit in their annual policy estimates, delivery of 50 bps rate cut looks certain. It may not be an easy decision for RBI given its concerns on inflation and exchange rate; there seems to be no other option but to “bite the bullet”! The tone of the policy may not be dovish but expected to be neutral with dovish bias if factors considered as major risks to inflation shape up to expectations; thus providing signals for CRR cuts in due course to drive operative policy rate from Repo rate to Reverse Repo rate, with an effective 150 bps rate adjustment (from current 8.5% to 7.0%) before end of Q2 of FY13. Over all, expectations of 50 bps rate cut and 125 bps CRR cut through H1 of FY13 remain unchanged. Thereafter, would look for stability with operative policy rate at 7% and CRR at 3.5% through H2 of FY13 and need-based liquidity injection to be done through OMOs to maintain operative policy rate at Reverse Repo rate; there is no case for SLR cut at this stage till fiscal prudence is achieved.

Interest rate market

Money market is steady (and back to normal) on shift into FY13; short term money market rates are down sharply into 9.0-10.0% across 3-12M tenor from the peak of 11.5-12.0% and deficit system liquidity is down below Rs.1 Trillion. However, Bond market has been volatile (in the medium to longer end) boxed between supply side concerns and strong expectation build-up for shift into dovish monetary policy stance by RBI. 10Y bond yield is down sharply from recent high of 8.79% to below 8.5% for close of week at 8.46%. The strategy to stay invested in 1Y bond at 8.45-8.65% (current 8.25%) and 1Y OIS at 8.15-8.25% (current 7.92%) has proved good and would get exit on post-policy rally into 8.10-8.0% (1Y bond) and 7.85-7.75% (1Y OIS). As mentioned in the report (What to expect from RBI on 17^th April?, released on 11^th April), 10Y bond yield has already moved into 8.25-8.5% range while 5Y OIS not getting enough momentum to take out strong support at 7.5% (close of week at 7.52%). Here again, bond swap strategy to buy 10Y bond above 8.65% with 5Y OIS hedge around 7.5% has proved good (with both positions in profit); spread is now squeezed from over 110 bps to 90 bps.

What next? The shift into second week of reporting fortnight cycle ending 20^th April will push draw down from LAF counter to below Rs.50K Crores and cut the gap between Repo rate and overnight MIBOR. It is time to look for move into the lower end of set short term ranges of 8.0-8.5% (1Y bond) and 7.75-8.25% (1Y OIS). Having seen test of higher end in the second fortnight of March, we are not far away from test of lower end. It is also fair (and prudent) at this stage to look for consolidation in 10Y bond at 8.35-8.50% with extension limited to 8.20-8.65%; hence strategy (for short term players) would be to unwind longs on extended gains into 8.35-8.20% and stay invested on weakness into 8.50-8.65%. This would set up consolidation in 5Y OIS rate at 7.40-7.60% with test/break either-way not expected to sustain; spread between 10Y bond yield and 5Y OIS rate is now expected to stay in consolidation mode at 90-110 bps till shift of operative policy rate from Repo rate to Reverse Repo rate. The chances of overnight MIBOR trending below 7% in coming years is very low; hence it is not a good risk-reward to stay “received” in 5Y OIS below 7.5%. It would be good for companies to “borrow short” to earn tenor premium with 5Y OIS “pay” hedge below 7.5%. For the week, let us watch 1Y bond at 8.10-8.25% and 1Y OIS at 7.75-7.95% with bias into lower end. On the longer end, watch 10Y bond yield at 8.35-8.55% and 5Y OIS rate at 7.45-7.60% with test/break either-way not expected to sustain for long.  

FX premium did over-shoot marginally beyond strong resistance at 8% in 3M and 6.25% in 12M and reversal from there held at 7.5% and 6.0% respectively before close of week at 7.7% (3M) and 6.1% (12M). Let us continue to stay with the set short term range of 7.0-8.0% (3M) and 5.75-6.25% (12M) with bias into lower end; trigger will be from rate cut action from RBI. These ranges (on 3M and 12M) has factored 50 bps rate cut and test/break below lower end will need shift of system liquidity from deficit to surplus mode; not expected to happen in the short term. It is also important for premium to stay at elevated levels to avoid pressure on spot rupee market from forward market. For the week, let us watch 7.0-7.75% (3M) and 5.75-6.10% with bias into lower end. The risk of test/break higher will be on strong exchange rate play driving spot rupee below 51.00. The strategy is to unwind “received book” (initiated at the higher end of set ranges) at 7.15-7.10% (3M) and 5.80-5.75% (12M) and await fresh cues for the next move.

Currency market

It was a good 35 pip trade from 51.44 to 51.06 and then from 51.64 to 51.29 before close of week at 51.30. Over all, two zones identified as good dollar supply zone at 51.40-51.45 and 51.60-51.65 held well to provide decent intra-day/over-night trading opportunity. The move to 51.60-51.65 triggered sale of December 2012 dollars above 54.00 (current at 53.67) and March 2013 dollars above 54.65 (current at 54.28). What next? There is no clear trend at this stage with rupee fundamentals remaining weak and vulnerable. Rupee fortunes now revolve around three critical factors; sustainability of FII flows, high FX premium and USD Index staying below 80. There seems to be no concerns from FII flows and FX premium; shift into growth-supportive monetary stance and resultant rally in equity market will attract FII interest despite issues related to GAAR and RBI can maintain higher FX premium through deregulation of FCNR rates and relaxation in off-shore borrowing limit for Banks. The critical factor is now the behaviour of USD against major currencies and the direction/trend revolves around QE3 at this stage. It is good for rupee bulls to see USD Index unable to hold on to its gains above 80 but reversal from there is shallow. Till we get clarity on QE3, USD Index is expected to stay in consolidation mode at 78.60-80.20 with overshoot limited to 78.10-80.70. Taking all these together, short term range for USD/INR pair is expected to be at 51.05-51.65 with overshoot limited to 50.65-52.05. It would need combination of good FII flows and weak USD Index to get the focus back into 50.30-49.80; not ruled out at this stage. Over all, downside risks to rupee is expected to stay limited to 52.05 while upside gains can extend all the way to 49.80. The strategy to sell December 2012 dollars above 54.00 and March 2013 dollars above 54.65 is valid; which could give a 50-75 pip profit in quick time for short term traders. For the week, let us watch consolidation 51.15-51.65 with overshoot limited to 50.90-51.90; immediate bias is for move into 51.65-51.90 which should hold. Strategic traders can look to sell in two lots at 51.60-51.65 and 51.90-51.95 for reversal into 51.15-51.10 and thereafter into 50.90-50.85. It is important for RBI to cut the interest rate play on FX premium to arrest interest rate driven rupee weakness beyond 51.65-51.90; else we get the focus into 52.05-52.20 before strong reversal. We need to keep this at the back our mind at this stage. However, there may not be significant change on the value of December 2012 and March 2013 dollars; hence the strategy to sell December 2012 dollars above 54.00 and March 2013 dollars above 54.65 to absorb higher premium (ahead of interest rate play) while enjoying time decay.

EUR/USD held above strong support zone of 1.3025-1.2975 (low of 1.3031) and bounce from there has been sharp into the immediate resistance zone of 1.3175-1.3225 (high of 1.3212) for close of week at 1.3075. EUR/USD is weak having come off sharply from above 1.32 and it is important for strong support at 1.3000-1.3035 to hold to maintain neutral (and consolidation) undertone within 1.30-1.33 into the near term; else 1.2900 comes into play to prevent extended weakness into 1.2625. For the week, let us watch 1.29-1.32 with bias into lower end. Intra-day traders can  stay “short” for this move while strategic players can choose to play end-to-end by selling at 1.3175-1.3225 (with stop above 1.3250) and buying at 1.2925-1.2875 (with stop below 1.2850).

USD/JPY pair is able to hold on to its weakness above strong support at 80.50 (low of 80.57) but recovery from there is very shallow for close of week at 80.90. Now, we may need to allow extended correction below 80.50 to 79 before reversal while 81.75-82.00 stays firm. For the week, let us watch 79-82 with bias into lower end which should hold. The strategy is to play end-to-end by selling at 81.50-82.00 (with stop at 82.25) and buying at 79.50-79.00 (with stop at 78.75).

EUR/JPY is holding well above strong support at 105.50 but continues to stay in bearish set up given the downside pressures on both EUR/USD and USD/JPY. The near term range now stands shifted to 102.50-107.50 with bias into lower end. The strategy is to trade from “short side” for this 250-300 pip move below 105.50. 

Equity market

NIFTY got good support at buy zone of 5225-5175 (low of 5190) but rally from there lost steam at 5306 before close of week at 5207. In the meanwhile DJIA held well at the strong support zone of 12750-12700 (low of 12710) for rally back to 12998 before close of week at 12850. The weekly close in NIFTY within 5225-5175 is neutral but would be seen as bulls losing the advantage. The near/short term outlook is not bearish but there are no strong signals for bull trend. While external cues are neutral (to supportive), attention will be on RBI’s Annual Monetary Policy review to provide directional break-out. The ability to hold above short term support at 5175 is positive and it would need RBI’s shift into growth supportive monetary policy stance to post strong rally through 5379; 5499 and further into short term objective at 5630. Any disappointments from RBI will be very bearish for swift fall below 5136 into 4588-4531. Let us not prefer this scenario at this stage. The momentum to this rally will be from western bourses and it is important for DJIA to stay above strong support zone of 12750-12700 for gradual move above strong resistance at 13300 (to reclaim recent high near 13300). Our expectation is to look for short term consolidation at 12700-13300 in DJIA and 5125-5625 in NIFTY with bias into upper end.  For the week, let us watch consolidation at 5175-5375 and await post-policy break-out into 5500-5625 while extended weakness to find strong buying above 5135. It would be a very good risk-reward trade to buy at 5175-5125 (with stop below 5100) for 5500-5625.

Commodity market

Gold traded end-to-end of set near term range of 1615-1685 before close of week at 1649. Given the mild bullish undertone of the USD Index and lack of clarity on QE3, upside gains will be limited; however expectation of QE3 in the last quarter of 2012 will attract good buying interest at 1615-1600. We continue to watch short term range play at 1600-1700 with break either-way not expected to sustain. For the week, let us continue to watch consolidation at 1615-1685 with immediate bias into lower end. The strategy is to play end-to-end of this move by selling at 1670-1685 and buying at 1615-1600 with tight affordable stop.

NYMEX Gold held within the set consolidation range of 101-104 and break either-way into weekly low of 100.68 and high of 104.24 set up trading opportunity before close of week at 102.90. The undertone continues to stay neutral with no clear momentum to provide a sustainable trend into the short term. For the week, let us watch consolidation at 100-105 with bias for extended weakness into 97-95 in due course. The strategy is to trade from short side (at 104-105) for 101-100 and thereafter into 96-95.

Have a great week ahead.................................Moses Harding

expectations from RBI on 17th April

It is high time for shift into growth supportive monetary stance

The economic woes now revolve around growth and fiscal/current account deficit after significant dilution on inflation fears. RBI has been in anti-inflation monetary stance since March 2010 and now in pause mode since October 2011. RBI did series of rate hikes and maintained system liquidity in deficit mode to keep operative policy rate at higher end of LAF corridor, the Repo rate to arrest demand-push pressures on inflation. A combination of economic woes and monetary tightening through tight liquidity and high cost of liquidity has killed investor sentiment and consumer confidence; both considered critical for economic development. The downtrend in growth momentum is sharp (into 6%) against a very ambitious FY13 target of 7.6% while inflation is expected to stay below 7% with support from consolidation in crude oil price and rupee. It is high time for RBI to shift into pro-growth monetary stance; considered critical at this stage to address economic woes relating to growth and fiscal deficit. But for the liquidity over-hang in western economies and good appetite for BRICS, conditions in India would have been worse. It is important to set the house in order before recovery picks up in western economies which could reduce investor appetite from external sector. It is also important to create conducive environment to attract long term FDI flows for capacity build-up in core sectors which are considered critical to spur growth (and consumption) to address fiscal deficit through higher revenues.

RBI has two options on hand: one, to shift system liquidity from deficit to surplus mode and the second, to cut policy rates more aggressively than expected. A combination of both would be very aggressive; hence not expected at this stage. RBI would need to deliver minimum 75 bps CRR cut to drive operative policy rate from 8.5% to 7.5% keeping policy rates unchanged. The other alternate is to deliver 50 bps rate cut to maintain operative policy rate at 8.0% keeping the system liquidity in deficit mode within RBI’s comfort level. Having said these, RBI has another option on hand; to cut CRR and policy rates by 25 bps each to maintain deficit system liquidity below its comfort level of 1% of NDTL and operative policy rate at 8.25%. This can be viewed as “baby step” action before shifting into higher gears on getting more clarity on downtrend in inflation and stability in crude oil price and rupee exchange rate.

Our earlier expectation was for delivery of 50 bps rate cut in one-shot on 17^th April or in two phases in April and June 2012 for shift of operative policy rate to 8% before end of Q1 of FY13. Thereafter, to trigger next round of CRR cuts to shift the system liquidity from deficit to surplus mode to drive operative policy rate to 7.0% before end of Q2 of FY13. This will help to have smooth sailing of heavily front-loaded borrowing calendar and maintain adequate system liquidity mode at affordable cost before shift into busy season from October 2012. Now, a new dimension has emerged from expectation of aggressive CRR cuts from large PSU Banks instead of rate cut action. This would mean that system moves into operative policy rate of 7.5% straight away without the first pit stop at 8%; delivery of rate cut thereafter would then push the operative policy rate to 7.0%; our final pit stop. So, the question is do we shift from 8.5 to 8.0 and then to 7.0% (our expectations) or from 8.5 to 7.5 and then to 7.0% (derived from expectations from top PSU Banks)? We cannot ignore opinions of large players which will mean a lot to RBI.

How will RBI act on 17^th April? One thing is certain, it will not be status-quo; there will be delivery of rate cut or CRR cut or combination of both. It is very difficult to choose one from these three options. It is considered prudent to cut policy rates having lowered CRR by 125 bps in quick time. We would put a weight of 51% for 25-50 bps rate cut (without CRR cut) and 49% weight on 25 bps cut each on policy rates and CRR. It would be a pleasant surprise if RBI delivers 75 bps CRR cut to provide one-shot 1% downward shift in operative policy rate. Having said these, it is very critical to shift the system liquidity into surplus mode soon to address growth concerns and to create demand for Government Bonds to cut cost of Government borrowing.

What is the impact on markets? There will be sharp rally in the shorter end with 1Y Bond yield into 8% and 1Y OIS into 7.75%. On the medium to longer end, there will be release of pressure to guide 10Y bond yield into consolidation play at 8.25-8.50% and 5Y OIS rate into consolidation mode at 7.35-7.50%. The positive sentiments will also help stock market to get the focus back on NIFTY into 5630 and get rupee bulls back into street to trigger rupee rally into 49.80. All these will bring cheer into the Indian economy and asset markets. It is high time for RBI to act to prevent the worst and to get the economy back on track. Over all, do not prefer extension of pause mode from RBI which will be very bearish on markets and the economy!

Moses Harding

    

MARKET PULSE - 11 APRIL 2012

MARKET PULSE: Short update for 11^th April

Currency market

The rally in USD/INR failed at the first sell zone of 51.40-51.45 (high of 51.41) and reversal from there lost steam at immediate support of 51.05 (low of 51.06) to set up a 35 pip trade; followed by next round of rally into next resistance zone of 51.60-51.65 (high of 51.64) and now expected to stay in consolidation mode at 51.40-51.65. Despite stability in USD Index within 79.60-80.00, rupee weakness got extended on the back of weak stock market. It is good for rupee bulls to see failure of USD Index at 80 to prevent extended weakness beyond 51.65 into 51.85-52.20, considered as worst case scenario for spot rupee at this stage. Let us now watch near term consolidation at 51.40-51.65 with overshoot limited to 51.05-51.85. The strategy is to sell in two lots at 51.60-51.65 and 51.80-51.85 and to buy in two lots at 51.10-51.05 and 50.90-50.85. Continue to watch December 2012 dollars above 54.00 and March 2013 dollars above 54.65 considered to hedge export receivables.

EUR/USD held well above strong support zone of 1.3025-1.2975 (low of 1.3031) for reversal into strong resistance at 1.3150-1.3175 (high of 1.3144) and in sideways trading mode within 1.3025-1.3150. There is no strong momentum for test/break either-way and if it does, it should stay limited to 1.2950-1.3250 within the set weekly range of 1.29-1.32. The strategy to buy at 1.2950-1.2900 and sell at 1.3150-1.3200 stays valid.

USD/JPY is holding well above strong support at 80.50 (low of 80.62) but not getting enough momentum for sharp reversal. This brings into play risk of extended weakness into 80.00-79.50 before sharp reversal while 81.75-82.00 remains safe. Let us now watch consolidation at 80.00-82.00 with overshoot limited to 79.50-82.50. The strategy is to buy at 80.00-79.50 (with stop loss at 79.25) and sell at 82.00-82.50 (with stop loss at 82.75); it is possible that we see end-to-end moves before setting up next directional break-out, bias for move back into 84.00-85.50.

EUR/JPY maintained its downtrend into strong support at 105.64 (low of 105.42) and continues to look weak for extension below this support for 104.25-103.50 while 106.75-107.00 stays firm. The strategy is to buy extended weakness into 104.00-103.50 (with stop below 103.25) for sharp reversal into 111.00-111.50.

Interest rate market

10Y bond yield reversed sharply from recent high of 8.79 to below 8.60% for close at 8.59% on rumours of increase in FII limit for investment in Government bonds. We are out on “longs” entered at 8.75-8.79% on move into t/p zone of 8.62-8.60%. Now, extended gains below 8.60% look bit stretched and seen as over-reaction to the FII news. Given the expectation of rate cut by majority of the stake holders and supply side concerns staying valid; it is fair to expect short term consolidation at 8.50-8.75% within the medium term range of 8.25-8.75%. The strategy now is to buy into weakness at 8.65-8.75% (revised down from earlier 8.75-8.85%) and to stay “short” on extended gains into 8.55-8.50%.

OIS rates found good support at lower end of 7.95-8.05% (1Y) and 7.50-7.65% (5Y) but reversal from there is shallow tracking softening yields in the bond market for close at 7.96% and 7.51% respectively. OIS market has priced-in 25-50 bps rate cut and would expect squeeze in 1X5 spread to 25 bps in due course with end June objective at 7.75% in 1Y and 7.50% in 5Y; thereafter on shift of operative policy rate from upper to lower end of LAF corridor will squeeze the 1X5 spread to par at 7.50%. Now, let us watch 1Y at 7.90-8.0% and 5Y at 7.45-7.60% with test/break either-way not expected to sustain. The strategy is to receive 1Y at 7.98-8.01% and pay 5Y at 7.47-7.44%.

FX premium is in bullish mode with 3M just below strong resistance at 8% and 12M just above the resistance at 6.25%. Let us continue to watch 7.5-8.0% in 3M and 5.75-6.25% in 12M. The market has not yet priced-in rate cut expectations and delivery of the same will drive the premium to lower end. The risk factor to this expectation is reversal in USD/INR spot from 51.50-50.65 to 50.80-50.65 which would trigger exchange rate play for spike higher into 8.25% (3M) and 6.5% (12M) before reversal. Let us stay aside for now and await fresh cues. It is good to receive 8% in 3M for ALM play to fund PCFC/FCL book against rupee sources with 90 day money market rate down below 10%.

Equity market

The bearish momentum (triggered by weak western bourses) found good support below 5225 (low of 5211) before close at 5243; ability to close above 5225 sends caution bells to the bears. However, bulls are not seen strong to get the focus back into 5350-5500. Let us not rule out extended weakness into 5175-5125 which should hold to maintain the neutral to bullish undertone. For now, let us watch 5175-5325 with overshoot limited to 5125-5375. Strategic investor can look to buy one-third of appetite at 5175-5125 for post-policy objective at 5625.

Have a great day.......................Moses Harding

MARKET PULSE: Weekly report for 09-13 April 2012

MARKET PULSE for the week 09-13 April 2012

Currency market

USD/INR traded end-to-end of “inner ring” of 50.50-51.50 (down from 51.40 to 50.51; up again to 51.23) within set near term range of 49.80-52.20 before close of week at 51.11. The shift into new financial year has cut the demand (for dollars) but weak economic fundamentals continue to weigh the rupee down; deficit in Q3 BoP, uncertainty in FII flows and strong reversal in USD Index from below 78.80 (to above 80) contributed to this swift reversal from 50.50 without providing an extension into 50.30-49.80. What next? The worries (and concerns) in the Euro zone continue to support the dollar while RBI’s shift into growth supportive monetary stance would provide relief to rupee. Given the mixed cues, there is no clear trend on the way forward and USD/INR is expected to stay in consolidation mode. It was not considered prudent to chase excessive rupee gains below 49 and now it is not wise to chase rupee weakness beyond 51. Based on these expectations, we considered it good for exporters to sell December 2012 dollars above 54 and March 2013 dollars above 54.60 and the reversal was sharp from the high of 54.05 (December 2012) and 54.65 (March 2013); reversal in FX premium and time decay would help. Let us continue to watch these levels which would help arrest spot rupee weakness beyond 51.50 and extended weakness into 52.20 will get adjusted in premium. For the week, let us watch consolidation at 50.90-51.40 with overshoot limited to 50.65-51.65. Beyond there, let us not rule out extended move into 51.85-52.20 if USD Index maintains its uptrend into 80.70 (ahead of 81.30). On the other hand, good FII flows will dilute the traction of USD/INR moves with USD Index to get the focus back below 50.65 (into 50.30-49.80). Let us stay neutral on directional break-out beyond 50.50-51.50 at this stage and await more cues for clarity. Strategic traders can look to sell USD/INR in two lots at 51.40-51.45 and 51.60-51.65 and look to buy in two lots at 50.90-50.85 and 50.70-50.65 with tight stop.

EUR/USD lost steam at strong resistance zone of 1.3375-1.3400 (high of 1.3380) for sharp reversal (low of 1.3033) before close of week at 1.3095. EUR/USD has now traded end-to-end of set short term range of 1.30-1.35 (up from 1.3003 to 1.3486 and back into 1.3033). What next? The bullish expectation on the US economy (resultant dilution in QE3) and absence of strong cues from the Euro zone (risk of shift into low growth; high inflation dynamics) will provide safe-haven support to the greenback. It is possible that EUR/USD has shifted into a new short term range of 1.27-1.32 with bias into the lower end. It is important for EUR/USD to hold above 1.2950 to get the focus back into 1.3250-1.3450. For the week, let us watch consolidation at 1.29-1.32 and stay neutral on break-out direction. The strategy is to play end-to-end of this range by selling at 1.3150-1.3200 and buying at 1.2950-1.2900 with tight stop on break thereof. Let us also keep the possibility of extended weakness into 1.2650-1.2600 on clear break below 1.2900 (initiating a stop-loss sell below 1.29 will set up a good risk-reward trade).

USD/JPY was in volatile mood but stayed within the “outer ring” of 81.00-83.50 range (high of 83.28 and low of 81.29) before close of week at 81.65. We expected this consolidation at 80-85 before getting the desired momentum for break higher. For the week, let us watch strong support above 80.50 and resistance at 83.50 (ahead of 84.25). The strategy is to trade end-to-end of this range by buying in two lots at 80.75 and 80.25 (with stop below 80.00) for 83.50-84.25. Let us also sell in two lots at 83.50 and 84.00 (with stop above 84.25) for 80.75-80.00.

EUR/JPY stayed weak on the back of Euro woes to hold below earlier sell zone of 111.25-111.50 (high of 111.11) and sharp reversal in USD/JPY provided momentum for swift reversal into 106.52 before close of week at 106.80. The focus is now on strong support at 105.64 and it is important for this level to stay safe to maintain short term consolidation at 105.50-111.50. For the week, let us watch sideways trading mode at 105.50-108.50. It is important for USD/JPY to hold above 80.50 to prevent extended weakness into 104.00-103.75. Let us stay aside on this pair this week but would look to buy extended weakness into 104.25-103.75 (with stop below 103.50) for sharp reversal into 110.00-111.50 in due course.

Interest rate market

The shift into FY13 has released pressure on the short term money market rates with overnight MIBOR down below 8.75% and 3-12M term money rate below 10.5%; draw down from LAF counter is also down below Rs.50K Crores at end of reporting fortnight cycle. 1Y OIS rate traded steady at 8.0-8.05% before close of week at 8.0% while 1Y Bond yield traded steady around 8.4%. The shift into new reporting fortnight cycle (starting 7^th April) will generate higher demand for funds this week with LAF drawdown expected to be around Rs.1 Trillion and call money rate trading around 8.75%. For the week, let us watch 1Y Bond yield steady at 8.30-8.40% and 1Y OIS rate at 7.95-8.05%. The immediate bias is for move into lower end by end of week in anticipation of lower demand for funds in the following week and good chances of rate cut on 17^th April. Strategy is to stay invested in 1Y bond and stay received in 1Y OIS rate  for post-policy objectives at 8.10% (1Y Bond) and 7.85% (1Y OIS) where we square positions and await fresh cues on the way forward.

10Y bond price fell post-auction to hit a high of 8.79% (8.79% 2021 bond trade at close to par value) but extended weakness (above 8.75%) attracted interest for weekly close at 8.68%. Our strategy was to stay invested on weakness into 8.75-8.85% keeping room for adding more at 8.95-9.0%; these levels are considered very attractive for strategic investments (into HTM), hence not expected to sustain. 5Y OIS rate has now traded end-to-end of set near term range of 7.50-7.65% (low of 7.49% and high of 7.64%) before close of week at 7.60%. There is strong bearish set up on the bond market with partial devolvement of the first weekly auction for FY13. The supply side concerns remain valid and despite higher yield, investor appetite is low. RBI needs to give clear road map on liquidity; cost of liquidity and OMO. It is important to shift system liquidity into surplus mode with 50 bps rate cut to have smooth sailing on RBI’s auction schedule. For the week, let us watch 10Y bond yield at 8.60-8.75% and 5Y OIS rate at 7.50-7.65% with test/break either-way to attract. The strategy is to exit long entered above 8.75% at 8.62-8.60% while fleet-footed traders play end-to-end of the set range with tight stop on break thereof. It is considered good to trade 5Y OIS from paid side (to enjoy decent carry); hence recommend staying paid at 7.53-7.48% (with stop below 7.45%) for 7.63-7.68%.

FX premium traded around midpoint of set ranges of 7.5-8.0% (3M) and 5.75-6.25% (12M) before close of week at 7.7% and 6% respectively. The strategy (after unwind of 12M received book at below 6%) was to reinstate received book in 12M at 6.10-6.25% (high of 6.15%) for post-policy objective at 5.65-5.50%. The moves in FX premium is now cut-off from interest rate play and driven by exchange rate play and given the expected consolidation in spot rupee at 50.50-51.50 in the immediate term, FX premium is expected to stay in consolidation mode within the set near term ranges. For the week, let us continue to watch 3M at 7.50-8.0% and 12M at 5.75-6.25% with test/break either-way to attract. The strategy is to receive 3M at 7.85-8.0% and 12M at 6.10-6.25% and await move into 7% (3M) and 5.5% (12M) where a short term base is expected to be formed.

Equity market

NIFTY was boxed between strong support at 5175-5125 (low of 5135) and resistance at 5375-5425 (high of 5378) before close of week at 5323; weekly close above 5225 provides great comfort to the bulls. In the meanwhile, DJIA lost momentum ahead of strong resistance below 13300 (high of 13297) for swift reversal into psychological big figure support of 13000 (low of 13012) before close of week at 13060. What next? The domestic factors have turned supportive for the bulls; sharp decline in MM rates and rate cut expectations on 17^th April will generate good appetite from domestic investors. The appetite from FIIs is set to accelerate on confirmation of shift of stance from RBI from neutral to growth supportive monetary policy. There is high possibility of extended strength in NIFTY into 5500 (ahead of 5630). The risk factor to this move will be on extended reversal in DJIA below 13000 into 12750-12725. Over all, undertone into the week is neutral to bullish. For the week, let us watch sideways trading mode at 5225-5500 with test/break either-way not expected to sustain. The strategy is to stay “long” for post-policy rally into 5630 while weakness below 5225 (into 5175-5125) will set up good short term buying opportunity for strategic investors.

Commodity market

Gold traded end-to-end of set weekly range of 1615-1685 (high of 1680.60 and low of 1611.80) before close of week at 1638. What next? Gold is in consolidation mode within the set short term range of 1600-1700; bulls losing steam on strong dollar and dilution in expectation of QE3 while low interest rates and abundant liquidity bring the bulls into the street at lower end. The bias has now shifted for extended weakness into 1565 (ahead of 1525) if strong support at 1605-1600 gives way. On the other side, the risk of extended gains beyond 1670-1680 (into 1700-1715) resistance is low. These expectations set up short term range play within 1565-1665 with overshoot limited to 1525-1705. For the week, let us watch consolidation at 1605-1670 and stay neutral on break-out direction. The strategy is to sell correction into 1665-1680 for eventual test/break of lower end for extended weakness into 1565-1550.

NYMEX Crude lost steam above the outer end of set weekly range of 100-105 for sharp reversal from high of 105.49 into 101.68 before close of week at 103.31. Over all, bulls have lost momentum by allowing gradual reversal from recent high of 110.55 into lower end of set short term range of 100-110. Now, we have shifted into a new short term range of 95-105 with bias into the lower end while gains above 105 may not hold. For the week, let us watch consolidation at 101-105 with bias for extended weakness into 98.50 while gains into 107 not expected to sustain. The strategy is to sell in two lots at 104.50-104.75 and 106.50-106.75 (with stop above 107) for 101.25-101.00 ahead of 98.75-98.50.

Have a great week ahead.........................Moses Harding

Money/Bond market outlook for FY13

Money/Bond market outlook for FY13

FY12 was traders delight with high confidence level on predictability of the trend. RBI continued with its hawkish stance on monetary policy till December and signalled shift into pause mode taking cues from establishment of downtrend in headline inflation and pressure on growth momentum. During this time, RBI maintained deficit system liquidity to keep money market rate curve at elevated levels. RBI did not have the option as the economy faced strong headwinds from external sector. The economic concerns were many driven by slippage in growth momentum; overshoot in fiscal deficit and inability to roll-out next generation economic reforms. The domestic and foreign investor confidence was low and consumer sentiment weak to put pressure on core growth and consumption. The system was operating on sub-optimal capacity, thereby not meeting budgeted revenues. FY12 was the year which the Government and RBI will like to take out from memory and look forward to much improved performance in FY13; it cannot go much worse from here. It is heartening to note that the market has traded to the script of MARKET PULSE in FY12. The recommendation was to stay invested in 10Y at yield 8.75-9.0% and to churn the book by exit at 8.25-8.10% by shift into 1Y bond at 8.50-8.65%. 10Y bond yield traded end-to-end of 8.15-8.85% with overshoot either-way could not sustain. 5Y OIS rate too traded end-to-end of 6.65-7.65% range to trigger pay recommendation below 6.75% for move into 7.65%. Over all, despite economic and monetary gloom, there were plenty of opportunities for investors and traders to make attractive returns on the principal; hence the FY12 investment strategy of 100% allotment in Fixed Income assets for capital preservation with attractive yield.

There is now tremendous pressure on the money market with low money supply and high demand from the Government. The shift in corporate credit demand from foreign currency to rupee since July 2011 Euro zone crisis has added to pressure. The leverage ratio has also gone up on significant cut in internal cash accruals of borrowers. RBI’s monetary stance of maintaining deficit system liquidity at elevated cost has extended beyond tolerance level. The way forward is highly dependent on the timing of shift of deficit system liquidity to surplus mode, thereby pushing the operative policy rate from Repo rate to Reverse Repo rate; resultant 1% downward shift in overnight rate curve will give flexibility to RBI to delay rate cut actions. Having said this, it would be very difficult to execute this plan with system shortfall at over Rs.1 Trillion; would need one-shot CRR cut by over 1.5% and continuation of OMO bond purchases to bridge demand-supply gap. Thereafter, RBI can choose to get into rate cut mode on getting comfort from factors that remain as major risk to inflation such as rupee exchange rate; crude oil price; core inflation and trend on Governments’ revenue/expenses as per projections. Needless to say, investors’ confidence (and appetite) will be high only when system is in surplus liquidity mode irrespective of the yield at that point of time; fear of lending to RBI (at Reverse Repo counter) will create demand. It is also important to give priority to growth issues to provide stability across asset markets and to cut bearish linkages.

The outlook for FY13 is mixed and is expected to turn bullish (and supportive) only on significant improvement in structural market dynamics. We believe that RBI will take quick remedial measures to address structural imbalances to provide better confidence on the way forward. Given this expectation, shorter end of the rate curve will benefit the most while bringing stability in the medium to longer end; establishment of downtrend in the shorter end and removal of bearish set up in the medium/longer end is considered positive at this stage. The expectation in FY13 is for delivery of 75-125 bps CRR cut; 50 bps rate cut and Rs.1.5-2.0 Trillion of OMO bond purchases. The timing of actions have to be front-ended (most in Q1 and rest in Q2) to get the best results. The expectation therefore will be for delivery of 50 bps rate cut in Q1; next round of CRR cuts in Q2 and OMO operations in Q3/Q4. This would mean shift of LAF corridor into 7.0-8.0% in Q1 (and for rest of FY13) and allow pass-through of operative policy rate from higher end to lower end in Q2 (and for rest of FY13).

What is the impact on the market? The average overnight MIBOR for FY13 will be around 7.75% with downtrend in 3-12M term money rates into 8.5-9.5% by end of Q2. This sets up objectives for 1Y bond yield at 8% and 1Y OIS rate at 7.75%. There will be significant release of pressure on the medium to longer end bonds. 10Y bond yield will look attractive at 8.75-8.85%; not ruling out extended weakness into 9.0% if unpleasant surprises come up. Strategic investors can look to buy this weakness into 8.75-8.85% with appetite to add on extended weakness into 8.95-9.0%. There will be trend reversal from there into 8.50-8.35% on improvement in factors that are considered as major risks to inflation and deterioration in factors that are considered as major risk to growth. The range to watch in FY13 for 10Y bond is at 8.50-8.85%; allowing unsustainable extension into 8.35-9.0%. This sets up FY13 range for 5Y OIS at 7.50-7.65% not ruling extended move within 7.35-7.80%. It would be good to initiate pay in 5Y OIS at 7.50-7.35% and build up received book at 7.65-7.80%. The major risk factor to this expectation is on pressure on inflation from rally in BRENT Crude over $135 and weak rupee over 53; considered as low probability at this stage. On the other side, rally in rupee into 47 and reversal in BRENT Crude below $115 would be very bullish for extended gains below the lower end of set ranges. It is not the time for RBI and the Government to take conflicting stance in their respective positions (Government’s priority for growth and RBI’s priority on inflation) and it would need balancing act to prevent slippage from bad to worse. This is the basic assumption that has driven the above expectations; believe, there is no second option at this point of time. It is not the time for investors to get panic on fear of the worst; it is the time to stay invested for good returns during the course of FY13.

Moses Harding           

NIFTY outlook for FY13

EQUITY MARKET OUTLOOK FOR FY13

Global liquidity and RBI’s growth supportive monetary stance to lift NIFTY

NIFTY closed FY12 in red with loss of over 9% down from 5834 to 5295; but for the late December rally from 4531, the pain would have been much severe. The intra-financial year loss from April high of 5944 to 4531 is very high at 23.75%; such is the volatility driven by FII play post Euro zone crisis and weak domestic cues since July 2011. FY12 is the year to forget; hence the investment strategy of MARKET PULSE for 2011 (“cash is king”) was to stay away from equity market and to ride the hardening interest rate cycle through investment in ultra-short term fixed income assets and to lock into longer tenor in the second fortnight of March 2012 at the peak of interest rate cycle. The objective was to preserve capital while earning decent returns on the principal. What next for FY13?

The external cues are mixed but seem to be out of the woods in the short/medium term; Euro zone is stable with combination of QE/LTRO financial support and there is minimal risk of disintegration of the Euro zone. US economy is showing signs of improvement and authorities are ready with QE3 to arrest any kind of weakness that may emerge. The policy stance of western economies to maintain ample system liquidity at very low interest rates till 2013-2014 provides good comfort to investors in FY13 if not beyond. The FII driven rally since late December 2011 highlights the confidence of off-shore investors and their strong appetite for Indian assets. There is no risk of FII pull-out who are expected to stay invested through FY13 with no signs of nervousness despite taxation issues (triggered in the Budget) and absence of political bandwidth to roll-out next generation economic reforms. The emergence of BRICS as economic power centre will keep India appetite high among global investors. The upgrade in India rating will lead to accelerated flows with intent to stay for long; removing the fear of “hot money” status.

The domestic cues are very weak; Government failed miserably in FY12 unable to meet its budgetary targets on all parameters; the slippage was huge. The mix of economic and monetary woes  is creating conflict of interest between RBI and the Government. The ability to meet FY13 budgetary targets on growth and fiscal deficit will be critical. On the other hand, RBI has to address the structural liquidity issues. The deficit system liquidity has to shift into surplus mode to drive the policy rate from Repo rate to Reverse Repo rate. This stance will be viewed bullish even without getting into rate cut action. There is very little support from domestic investors at this stage. The fixed income returns are very attractive while most strategic investors have turned passive having lost capital and interest on their investments since 2008-2010 when NIFTY peaked around 6338-6357; current levels are still below water by more than 15%.

It is possible that NIFTY has already formed a strong base at 5125-5175 support zone and looks good for extended rally into 5950-6000. The chances of taking out the high seen at 6357 (Jan 2008) and 6338 (November 2010) are bright on combination of bullish cues both from domestic and external sectors. The risk factor to this expectation can only be from RBI if they choose to delay shift into accommodative monetary policy stance; elevated interest rate regime (with tight liquidity) for extended period of time is big risk to equity market. Given the over-heated Bond market with 10Y yield flying over 8.65% (into 9%), RBI cannot afford to delay any further. RBI’s rate action on 17^th April (followed by next round in mid June) and shift of operative policy rate from higher end to lower end of LAF corridor (before end of Q2) will be the trigger for sharp rally into the set objectives. The prudent investment strategy for FY13 is to have equal distribution between Equity and Fixed Income assets. May be, FY13 is the year for the bulls having lost the battle in FY12!

Moses Harding   

USD/INR outlook for FY13

Rupee Outlook for FY13

Rupee fortunes continue to stay dependent on hot money FII flows

FY12 was one of the worst years for rupee; down from 44.59 to 50.87 at an annualised rate of over 14%. The most alarming phase was between July to December when rupee went down from 43.85 to 54.30 by 24% in less than 5 months time. On the other hand, USD Index was up from 75.86 to 78.95 in FY12 with an annualised gain of over 4%. There are many fundamentals reasons for underperformance of rupee but most striking is its dependence on lumpy FII flows; weak fundamentals are discounted on good FII flows and get exaggerated on FII pull out. There is no political consensus to attract FDI into India to stay less dependent on volatile FII flows. It is not unfair to say that rupee exchange rate is controlled by FIIs and resultant excessive volatility makes things difficult for RBI.

The fundamentals woes for rupee arising from huge Current Account deficit continue to stay valid for decades now. There are no signs of structural remedies to cut dependence on imports and to boost exports. There is constant need to bridge this gap through accelerated and sustainable flows through capital account and maintain over-valuation of forward dollar to keep forward market in supply driven mode; simultaneous pressure from forward market and decline in capital account flows will put pressure on rupee. Then, there is another major issue of bunched up dollar demand in the cash market from PSU entities with no efforts to smoothen this demand into a phased manner. Given these complexities and high dependence on external sector (and forces), rupee will continue to stand out in relative performance to either the US Dollar or other peer group currencies with excessive (or extended) strength or weakness.

What is the outlook for FY13? There are no signs of improvement in Current Account deficit given the high crude oil price and low demand for India’s goods and services from the external sector. The support from carry-trade flows is on decline having lost the cost advantage driven by higher liquidity/credit spread and FX premium. Given this scenario, it is important to study FII behaviour to project a trading band for rupee for FY13. FIIs continue to view India as attractive destination and find debt and equity assets as good for investments; being member of BRICS community helps. The liquidity over-hang in Western markets and low interest regime till 2013-2014 is positive for rupee. Interest rates in debt market will continue to stay attractive in FY13 given the limited downside pressures for sharp reversal in interest rates. There are no signs of bearish set up on equity assets despite outperformance of western bourses over India. DJIA is below the pre-Lehman Bros high of 14198 by 7.5% (at current 13250) while NIFTY is behind by 19% from 2008 high of 6357. Then, there are political; economic and monetary issues providing strong headwinds to accelerated FII/FDI flows. It is critical for establishing sustainable bullish set up in equity market to prevent rupee weakness. The dilution in rate cut expectations will keep investor appetite intact for fixed income assets. It is also important that western economies do not get into either recessionary mode or strong economic revival mode; either of which can trigger FII pull-out. The lessons from the past is that bearish set up on rupee could be swift while bullish reversal will be shallow and would need RBI’s support; downside risks can be sharp and upside gains will stay limited to maintain export competitiveness and the need for RBI to shift rupee assets into dollars in its Balance Sheet.

What is the trading range for rupee in FY13? There are lot of factors to track to fix a broad range for rupee. Factor that could put pressure on trade gap is the behaviour of BRENT Crude while economy is in business as usual mode to effect significant variance in top-line imports and exports performance. The movement in Balance of Payment is critical. We have seen huge deficit in Q3 of FY12 triggered by FIIs exit but it was good to see the re-entry in Q4 that should shift BoP into positive in Q4; also supported by accelerated NRI flows on deregulation of interest rates. It needs to be seen whether RBI will retain the tax advantage available to NRE Rupee deposits. There are no bullish cues at this stage to take comfort from sustainable FII flows; it could be volatile as seen between Q3 and Q4 of FY12. There is no clear trend on USD Index; relatively good performance of US economy and expectation of QE3 will keep global investors in “risk-on” mode to provide consolidation with no clear signals of establishing either a bearish or bullish trend. The trading range for USD Index for FY13 is expected to be at 76.10-82.60 (EUR/USD at 1.27-1.38). There is serious concern from crude oil price; excessive liquidity in western markets could drive commodity prices up with added fears from geo-political concerns. It is difficult to get clear trend on the three most critical factors of FII behaviour; BRENT Crude price and USD Index. This would mean that domestic cues should establish “pull” triggers to attract external liquidity. It is important to get the trend right on growth; inflation and fiscal consolidation. The shift of RBI into growth supportive stance and efficiency of the Government to manage costs will be critical at this stage. There are strong reasons to believe that RBI and Government will take necessary steps to get the Indian economy out of the woods that could provide great comfort to FIIs to stay invested in Indian markets; opening of carry-trade flows through shift of credit demand from rupees to foreign currency will be icing on the cake. The trading range for rupee for FY13 is expected to be at 47.80-52.15 with overshoot limited to 46-53. There is no clarity on establishment of clear trend at this stage; hence it would be prudent to close exchange rate exposures on move into outer ends of the said range. The strategy (and recommendation) in MARKET PULSE was to sell December 2012 dollars above 54.00 and to sell March 2013 dollars above 54.50; reversal from these levels (on recent spot weakness into 51.50) has been sharp. The chance of extended gains in rupee into 47.80-46.00 is high while weakness beyond 52.15-53.00 is low. May be, FY13 is the year for the rupee bulls having lost the battle in FY12!

Moses Harding    

MARKET PULSE - Weekly report for 02-06 April 2012

Market Pulse: Weekly report for 2-6 April 2012

Currency market

The rally in USD/INR from 50.62 passed through the first sell zone of 51.10-51.15 but lost steam ahead of second sell zone at 51.45-51.50 (high of 51.40) before strong reversal into 50.81 for close of FY12 at 50.88. The bearish set up on rupee post-budget (into 51.50) and high forward premium in 9-12M tenor provided good opportunity to cover December 2012 exports above 54.00 (high of 54.04) and March 2013 exports above 54.50 (high of 54.65). These are all very critical levels considered good to lock in higher rupee realisation (for exports) given the risk (and possibility) of reversal into recent low of 48.60 (and further into 47) on general dollar weakness; nothing is impossible in the market. Even if spot USD/INR moves up (beyond 51.50), adjustment in FX premium may not result in significant opportunity loss.  It is important to avoid real losses unmindful of marginal opportunity loss; it is impossible to catch the tail or the head of the market moves. What next? There are some positive cues for the rupee. RBI may get into growth supportive monetary stance after delivery of an unexpected FY end OMO; crude oil is showing good signs of reversal and there is no risk of pull-out from FIIs at this stage. The deficit in Q3 Balance of Payment may be considered as one-off and expected to be back into positive in Q4/FY12 and into FY13. USD Index is unable to hold on to its gain above 79.20 and looks weak for reversal into 78.20-78.00 in the immediate term. Taking all these together, trading range for the week is at 50.30-51.15; break of lower end to get the focus into 49.80. The risk of test/break of higher end (into 51.50) is low at this stage. Over all, it is possible that USD/INR gets into consolidation mode at 50-51 in the near term. Let us now consider unwind of December 2012 shorts entered at 54.00-54.05 at 52 (current 53.26) on spot dollar move into 49.80 and March 2013 shorts entered at 54.50-54.65 at 52.50 (current 53.85). Strategic traders who are already short in spot at 51.15-50.40 can trail stop at 51.05 for 50.05-49.80. It is possible that USD/INR will get into consolidation mode in the short term at 50-51 with overshoot limited to 49.50-51.50. Let us have close watch on three factors which will set the directional break-out; BRENT crude at 120-130, USD Index at 78.00-79.50 and trend in FX premium – downtrend in FX premium below 7% in 3M and 5% in 12M will make forward dollars look cheap for importers. RBI may need to deregulate FCNR rates to arrest premium impact on spot rupee.  

EUR/USD found good support at the buy zone of 1.3300-1.3250 (low of 1.3251) and reversal from there lost steam ahead of strong resistance/earlier sell zone of 1.3375-1.3425 (high of 1.3380). It is not in the interest of the Euro bulls to see repeated failure at the strong resistance zone of 1.3375-1.3400 but dollar bulls do not have the strength to provide sustainable push below 1.33. The immediate term range is now seen at 1.3250-1.3450 with overshoot limited to 1.32-1.35. The strategy is to play end-to-end of this move by buying at 1.3250-1.3200 (with stop at 1.3175) and selling at 1.3450-1.3500 (with stop at 1.3525).   

USD/JPY reversed sharply from 83.50 to take out immediate support at 82.50 for extension into the set buy zone of 82.25-81.75 (low of 81.82) for sharp reversal from there into 83.25-83.50 (high of 83.28) and back again into 82.50. Over all, in this run it has traded between the set buy zone of 82.00-81.75 and sell zone of 83.25-83.50. There is no change in view of looking for consolidation at 81.75-83.50 with overshoot limited to 81.00-84.25. The strategy is to play end-to-end of this range by buying at 82.00-81.75 and selling at 84.00-84.25. Over all, short term range is set at 80-85 with test/break either-way not expected to sustain for long.

EUR/JPY is in consolidation mode at now familiar range of 108.50-111.50 (low of 108.73 and high of 111.11) with no momentum to test/break either-way. The upside break is resisted by lack of strength in EUR/USD above 1.3400 and extended weakness below 108.50 is losing steam on USD/JPY rally from below 82.00. Given the EUR/USD stability at 1.33-1.34 and USD/JPY at 82.50-83.50; EUR/JPY is expected to be boxed at 109-112. The strategy is to play trade end-to-end of this move by buying at 109.00-108.50 (with stop below 108.25) and selling at 112.00-112.50 (with stop at 112.75).

Interest rate market

The shift into FY13 will release pressure on money market rates and tight liquidity. The deficit system liquidity will ease into RBI’s comfort zone of 1% of NDTL soon and 3-12M money market rate curve to stabilise within 9.0-10%. The expectation in Q1 is for maintenance of operative policy rate at higher end of LAF corridor and 50 bps rate cut action; either in one-shot or in two phases. The bias is in favour of 25 bps rate cut on 17^th April followed by the next one in June mid quarter review for end Q1 operative policy rate of 8%. Given these expectations, 1Y Bond yield remained steady around 8.40% and 1Y OIS rate has eased into the set objectives at 8.0-7.90%; low of 7.97% (take profit zone for received book entered at 8.25%) before close of FY12 at 8.06%. There will be good appetite for shorter tenor bonds (up to 1 year) in expectation of much higher yields on medium/long tenor bonds. For the week, let us watch call money rate around 8.65%; 1Y Bond yield at 8.25-8.40% and 1Y OIS rate at 7.95-8.15% with bias into lower end. The trading strategy is to hold on to 1Y Bond investments entered at 8.40-8.50%; add at 8.40-8.45% (for Q2 objective at 7.90-8.0%). It would be good to re-build 1Y OIS book by receiving at 8.10-8.15% (for Q2 objective at 7.65-7.75%).

10Y Bond yield and 5Y OIS rate has now traded end-to-end of set near term ranges of 8.50-8.65% (10Y bond) and 7.50-7.65% (5Y OIS) before close of FY12 at 8.57% and 7.57% respectively; thus maintaining the 1% bond spread. The undertone is very bearish for extended weakness above the higher end of set ranges. Q1 is loaded with huge week-on-week supplies with very low investor appetite. There may not be significant impact on injection of liquidity through CRR cut; it would need aggressive rate cut and OMO to prevent extended weakness. The domestic fundamentals do not provide leverage (and/or required band width) for RBI to support Bond market; aggressive rate cut actions are not in the radar and it is not considered efficient if RBI choose to absorb entire Government borrowing in its books through OMO. The best case scenario for 10Y bond yield seems not beyond 8.35% (on delivery of 50 bps rate cut and alternate week OMO bond purchases) and in the absence of this support, 10Y bond yield will spike higher into 8.85%, considered as worst case scenario at this stage for short term trading range for 10Y bond at 8.35-8.85%. This sets up 5Y OIS rate at 7.35-7.85% with steady 1% spread between 10Y bond yield and 5Y OIS rate. For the week, let us watch 10Y bond yield at 8.50-8.65% and 5Y OIS rate at 7.50-7.65% with test/break either-way to attract. The plan for strategic investors is to exit 10Y bond on gains into 8.50-8.35% (by shift into shorter tenor of 1-2 years); pay 5Y OIS at 7.50-7.35% and enter into Bond Swap trade on spike in 10Y bond yield into 8.65-8.85%.  

FX premium nicely moved into expected FY13 range of 7-8% (3M) and 5.5-6.0% (12M) from recent high of 9% and 6.85% respectively for FY12 close at 7.80% and 5.90%. Let us wait to unwind “received book” entered at 8.75-9.0% in 3M and 6.70-6.85% in 12M on move into lower end of set ranges with trail stop above 8% and 6.0% respectively. It is important for premium to stay within the said ranges (in Q1 of FY13) to provide stability in both exchange rate and money market rates; sharp reversal in premium below the lower end will add  to pressure on rupee while spike over higher end will arrest downtrend in  money market rates. Beyond there, directional break-out will be triggered by exchange rate play on USD/INR setting the trend either into 47 or into 54. Given the lack of clarity on the trend, we prefer consolidation at this stage. For the week, let us watch sideways trading mode at 7.5-8.0% in 3M and 5.75-6.25% in 12M with test/break either-way not expected to sustain. The trading strategy is to await test/break of either end and would prefer to trade from received side given the 50 bps rate cut expectation in Q1 which would guide 3M into 7% and 12M into 5%. These levels are seen as strong “floor” into short/medium term. The trade strategy is to receive 12M at 6.10-6.25% for 5.5%.

Equity market

The reversal in NIFTY from strong resistance/sell zone of 5250-5300 (high of 5278) extended below 5175 but held well at the next support zone of 5125-5145 (low of 5136) for sharp reversal into 5300-5350. There are no strong cues at this stage to establish a clear trend; factors and expectations are mixed and neutral. There is good support to NIFTY from bullish sentiments in DJIA and liquidity over-hang in the western markets; however emerging markets are into low-growth dynamics. The big economies of Asia; China and Japan are looking weak. On the domestic side, sentiments are very weak driven by all kinds of economic and monetary woes with limited comfort on roll-out of credible remedial actions. All attention is on the RBI now; its act of compromise to get into rate cut actions and shift of system liquidity from deficit to surplus mode would help to generate investment appetite from domestic investors. It is possible that NIFTY gets into consolidation mode till trend clarity emerges on fiscal deficit; current account deficit; rupee exchange rate; crude oil price; core inflation and growth. Till then, it would be in order to allow consolidation at 5000-5500. For the week, let us watch 5175-5475 and stay neutral on the break-out direction which can extend to 5000 or 5650. The strategy for now is to stay aside and await more clarity on the way forward. However expectation of rate cut either on 17^th April or latest by mid June, should generate buying interest at 5225-5175; fleet footed traders can look to buy here with tight stop for 5450-5475.

Commodity market

Gold is in perfect traction with USD Index; consolidation at 78.20-79.20 triggered end-to-end trade between sell zone of 1685-1700 (high of 1696) and buy zone of 1665-1650 (low of 1645) for back into consolidation mode at 1660-1670. The trend seems to be down at this stage for gradual reversal into 1615-1610 ahead of 1585-1550. The bulls are not having the strength to push the value beyond 1685-1700. For the week, let us watch sideways trading mode at 1615-1685 with overshoot limited to 1600-1700. The strategy is to play end-to-end by selling at 1685-1700 for buy back at 1615-1600.

NYMEX Crude reversed sharply below the familiar range of 103-108 (low of 102.13) on G2 intervention (release from strategic reserves by US and UK) and in consolidation mode around 103. This is the risk factor that was highlighted to keep the bulls under check; however, bears are not in a position to take command given the vulnerable geo-political issues. However, it is good for the global economy to retain consolidation mode at 95-110. It is also possible that there will be dilution on political fears to get the focus below 100 soon. For now, the trading range is shifted to 100-105 within near term range of 95-108. The strategy is to play from “short” side for this move.

Have a great week ahead. Next update is on 9^th April 2012. Have a great extended weekend

Moses Harding