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 16th 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
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