MARKET PULSE for 16th May 2012
Currency market
USD/INR nicely moved into the sell zone of 53.90-54.30 considered good for exporters to cover 3M dollars at value above 55 (high of 54.06 in spot and high of 55.01 on 3M); this zone is considered critical in anticipation of RBI’s strong-arm tactics to prevent rupee posting new low beyond 54.30. RBI’s strong intervention (dollar sales over 54.00) could drive USD/INR to low of 53.59 (into the buy zone of 53.60-53.35; considered good to buy 1-2M forward dollar at value below 54) before close of day at 53.80. RBI has been successful so far to defend 53.90 (on daily closing basis) and to prevent extend rupee weakness into 54.30. The fundamentals have not turned supportive to rupee; the recent data on growth and inflation is negative. The flow into debt/equity capital market is scarce. The most critical factor will be to turn the forward market into supply driven mode; even a lead of 3M export receivables will matter a lot to drive the spot USD/INR down which in-turn will drive premium up to keep importers away from the scene. But, this is not going to happen overnight given the bearish sentiment in the external sector; specially trigger of disintegration fears in the Euro zone. The strategy of MARKET PULSE remains unchanged: to hedge 3M receivables at above 55 (despite risk of USD/INR spot weakness beyond 54.30 which can be used to cover exports beyond 3M tenor) and to cover 1-2M payables below 54.00; thus providing strong support to USD/INR pair at 53.60-53.35 and resistance at 54.00-54.20. Let us continue to watch consolidation at 53.60-54.10 with extension limited to 53.30-54.30; immediate bias is for move into 54.10-54.30 to activate aggressive dollar sales from RBI and follow-on verbal intervention to cut flow of big ticket demand into the market. USD Index after a brief correction from first objective at 80.70 is now on its way into the next objective at 81.75; impact of which would drive rupee into 54.30. This is the risk factor we need to keep in our mind and watch RBI’s actions either to strongly defend rupee or allow to find a new floor above 54.30. The undertone is negative; trend for rupee is bearish and RBI is struggling against strong headwinds, hence it may not be easy to defend 54.30 at this stage when USD is gaining strong grounds against major currencies and global bourses continue to maintain downward pressure. Rupee gains below 53.60-53.30 would need RBI to take operating control of the FX market which then would drive rupee into 52.00, lower end of the set short term range of 52-57.
EUR/USD met its first objective at 1.2750 (low of 1.2752) and on its way to the next objective at 1.2625, not ruling out further extension below 1.25. Strategy is to hold on to “shorts” with trail stop above 1.2800; if stopped sell again at 1.2850-1.2900 (with stop above 1.2925) for 1.2625/1.2475.
USD/JPY is in tight range trade around 80 (between 79.80 and 80.20) while EUR/JPY is holding above strong support at 102.25. While there is clarity is EUR/JPY looking for extended weakness into 101.50-100.50 (for further weakness into 97.00), let us stay neutral in USD/JPY and prefer to play end-to-end of 79.10-80.60 range by selling at 80.40-80.60 and buying at 79.30-79.10 with tight affordable stop.
Interest rate market
The surprise second round of OMO eased pressure in the Bond market to guide 10Y bond yield below 8.50% (low of 8.47% before close at 8.50%) and 5Y OIS rate below 7.45% (low of 7.43% before close at 7.47%). However, shorter end of the curve stayed firm with 1Y OIS around 8.05% and 1Y Bond yield up at 8.35%. As said, RBI’s aggressive stance to defend rupee is at the expense of Money market. The system deficit liquidity is considered structural and RBI cannot afford to pull-out rupees from the system to defend rupee. There is little RBI could do in the FX forward market as B/S swaps and resultant lower FX premium will lead to higher demand for forward dollars. The only option (other than CRR cut) is to conduct OMO operations as frequently as possible. So, there will be comfort to investors till OMO is out of the way bringing supply side pressures into focus. Now, week-on-week (or alternate week) OMO would push 10Y Bond yield to the lower end of set short term range of 8.35-8.65%. This would provide opportunities to traders: to buy ahead of OMO; sell ahead of auction and buy-back on auction. This cycle will provide two-way sideways trading within 8.40-8.50% with extension limited to 8.35-8.55%. The strategy is to play end-to-end of this move by staying long at 8.51-8.54% (with stop at 8.56%) and being “short” at 8.40-8.35%. Strategic investor can cut the duration of the portfolio with near zero dilution in the portfolio yield (replacing 10Y below 8.40% with 1Y above 8.35%) with good chance of getting re-entry at 8.65-8.75% in due course. In line with this expectation in Bond market, we may need to revise range of 5Y OIS rate into 7.40-7.55%. It is possible that RBI will continue its OMO (week-on-week basis) as its operation to defend rupee will be an extended one. If RBI decides to allow rupee to find its own floor, then Bond supplies (without matching OMOs) would kick in sharp reversal into 8.60-8.65%; hence prudent to trade OIS from paid side. Let us continue to watch 1Y at 8.0-8.10% with bias into higher end and two-way sideways trading mode in 5Y at 7.45-7.50% with test/break either-way to attract. Strategic players to stay paid on test/break of lower end (into 7.40%) for spike into 7.60-7.65% tracking 10Y yield into 8.60-8.65% in due course.
FX premium eased into the lower end of 6.75% (3M) and 5% (12M) on exchange rate play driven by higher spot into 53.90-54.10 but spot reversal from there below 53.80 pushed it back for close at 7% and 5.15% respectively. Now, let us watch consolidation at 6.75-7.25% (3M) and 4.90-5.20% (12M); test/break of lower end will set up good paying opportunity for sharp reversal into higher end. Fleet footed traders can play end-to-end of this range with tight stop on break thereof. Strategic players can look to build paid book below 4.9% in 12M (looks good against 12M CD rate of 10% providing LIBOR yield of 5.1%). This scenario will be good to attract NRE flows to release pressure on rupee. RBI can consider allowing NRIs to convert FCNR into NRE on payment of dollar interest for the run-period of deposit, to avoid incurring premature closure cost. This will also enable market to absorb B/S swaps of RBI without exerting downward pressure on FX premium.
Equity market
We had set a tight weekly range of 4825-4975 and have seen back-and-forth moves within low of 4869 and high of 4957 before close at 4942. The sentiment is very weak; economic data from India continue to indicate pressure on growth and elevated inflation. The external environment is bad; Euro zone crisis continues to haunt the investors with little optimism from big brother US economy. DJIA is already below the strong support zone of 12710-12735 (low of 12661/daily close of 12695); daily close below this strong support zone opens up risk of gradual weakness into 12220-12200. With weak domestic cues and lack of support from western bourses, trend into the near term is bearish with immediate objective at 4825-4775. Let us continue to watch consolidation at 4825-5000; initial gains into higher end would attract to prepare momentum for move below 4825. The strategy is to stay “short” at 4975-5025 with stop above 5050 for the set objectives.
Have a great day ahead..............................Moses Harding
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