MARKET PULSE - Special update

MARKET PULSE: Special update (near term perspective)

Currency market

Rupee posted yet another new all-time intraday low at 54.58 but managed to end the day at 54.48, one paisa below the previous low of 54.49 (daily close basis) thanks to aggressive dollar sales by RBI above 54.50. Our recent strategy was to cover 3M payables at forward value below 54 and spot rupee could not extend its gains beyond 52.95 (post strictures on EEFC) for sharp reversal to take out 54.30 driven by USD Index rally into 81.50-81.75 resistance zone. It is not that we wish rupee to fall but the fact is that RBI does not have enough ammunition to fight against Tsunami like ferocious headwinds across all sides. To add fuel to fire, weak macro fundamentals and negative domestic sentiments hurt rupee more when USD is in rally mode and any gains remain shallow on correction in USD Index (and spike in EUR/USD). We also asked exporters to sell part of 3M dollar receivables at 55.00-55.20 on spot weakness into 54.10-54.30 (despite expectation of new low over 54.30) with sense of patriotism and support to RBI. It is true that rupee weakness beyond 54.30 is excessive, sharp fall in rupee from 43.85 (to 54.30) since Euro zone crisis in July 2011 more than adequately captures the weak macro fundamentals and negative investor/business sentiments but strong market forces in favour of USD has created panic in a heavily (dollar) over-sold market and risk of pull out of hot money/fair weather investments. It should be noted that most exporters are hedged, most importers are uncovered, short/medium/long term foreign currency liabilities are open and those who shifted rupee liability to dollar for interest cost advantage are in the red and if all these positions come up for closure, it would be very painful. Added to this, if 3-6M import cover comes up at the same time, it would be disastrous. RBI does not have deep dollar pockets or the domestic system in a position to absorb resultant rupee liquidity squeeze. The picture is grim and our dependence on hot money inflows and poor risk management practices (to stay oversold in dollars) is exposed yet again. It is high time the Government and the RBI set up high level committees to address structural issues (political reforms, fiscal consolidation and inflation control) once and for all. We are already into the third decade of economic reforms (since 1991) but continue to be swayed by forces beyond our control. What next? USD/INR will get into traction with USD Index and EUR/USD. USD Index is looking good for extended gains into 82.60 (on test/break of 81.78) with short term target at 85.25. This rally in USD Index can push EUR/USD down to 1.2550 with short term target at 1.22.  The mirror reflection of these moves sets up target for rupee at 55.25 with short term target at 57.00. Rupee recovery has to be driven by sharp reversal in USD Index into 78.10 which can then provide relief for rupee into 52.80-52.30; now considered as strong base for the USD/INR currency pair. All these validate the set short term range for rupee at 52-57. In the absence of reversal in USD Index, RBI can drive rupee reversal (to set targets) through measures like Special Market Operations (to absorb dollar demand from Oil PSUs); allowing importers to postpone import pay out through extended buyers’/suppliers’ credit beyond 12M tenor; forcing exporters to sell future realisation on post-shipment basis; removal of off-shore borrowing limits for Banks/companies and in worst case scenario to raise long term money from NRIs. The risk factor is that of possible exit by FIIs from equity market on availability of USD at subsidised rate which can drive the NIFTY below recent low of 4531. FIIs may prefer either to stay in cash or invested in debt till the Government starts taking aggressive steps to address structural issues on hand. For now, there will be dollar demand from importers to buy forward dollars below 54.50 which will limit spot rupee recovery to 54.10 but not beyond 53.50 (3M dollar below 54.50). On the other side, 3M forward dollars at 56-57 may lead supplies from exporters into the forward market; thus setting up strong support for rupee around 55.50, midpoint of the set short term range of 52.57. So, taking all these together it is good to watch consolidation at “inner ring” of 53.50-55.50 with bias into higher end. Strategy for importers is to cover 1M dollars around 54.50 (spot at 54.10) and 3M dollars around 54.50 (spot at 53.50) while exporters stay away for spot into 55.50-57.00 having already covered 3M dollars at 55.00-55.20.

EUR/USD is steadily trending down and has now convincingly taken out strong support at 1.2750 and looks good for test/break of 1.2625 (low of January 2012) which then could extend all the way to 1.22 and 1.1875 (low of January 2010). MARKET PULSE strategy since July 2011 Euro zone crisis was to stay fully hedged on exports; fall from 1.4939 since then has been steep. There will be bad news coming out of PIIGS to provide momentum to Euro’s fall but it has to reverse from some point. The trigger for this may be on exit of problem countries from the common Euro currency; so, let us not chase Euro weakness into 1.22-1.19 and consider this as good to unwind strategic “short” positions and to stay covered on imports. For now, any “correction” in EUR/USD should not extend beyond 1.28-1.29 resistance zone for gradual move into 1.22-1.19 on clear break below 1.2625-1.2550 support window.

USD/JPY traded as per script for sharp rally from 75.55 (low of November 2011) to 84.17 (high of March 2012) before losing steam for push back to low of 79.41 and now in consolidation mode around 80. The strategy of MARKET PULSE was to trade end-to-end of 75-85 and also suggested companies to convert USD liability to JPY at lower end for back into USD around 85. Now, it is possible that USD/JPY has shifted into a new range of 78-83; there may not be momentum for test/break either-way, hence would look for end-to-end consolidation.

Interest rate market

Money market is feeling the heat of RBI’s FX intervention; liquidity is tight and draw down from LAF continue to stay over Rs.1 Trillion despite CRR/OMO actions. 3-12M money market rate are up at 10% despite 50 bps rate cut. RBI has already completed two rounds of OMO for FY13 and next round of CRR cuts is round the corner, at least by 50 bps during the mid quarter review in June. Rate cut actions are out of the radar and expectation of shift of operative policy rate from Repo to Reverse Repo rate may be delayed given the severe strain on system liquidity. The system need to stay with 8% operative policy rate into the short term. Over all, impact of 50 bps rate cut and 125 bps CRR cut may not be passed through to borrowers when cost of money is expected to stay at elevated levels into the short term. Till mid quarter review, overnight MIBOR is expected to stay at higher end of 8.25-8.5% while 1Y Bond and OIS rates stay in consolidation mode at 8.35-8.50% and 8.0-8.10% respectively.

10Y Bond yield is in consolidation mode around 8.50% post trigger of OMOs by RBI. MARKET PULSE strategy to stay invested at 8.60-8.65% and to shift long term investments into shorter tenor on rally into 8.35-8.25% has been good; initial weakness into 8.69% reversed sharply to 8.30% post rate cut and back to consolidation mode at 8.45-8.60% on expectation of OMOs every alternate week if not on weekly basis. As before, stability in 10Y bond is highly dependent on extent of OMOs from RBI as all other factors point to high level of bearish set up for weakness beyond 8.65-8.75%. Let us watch consolidation in 10Y Bond yield at 8.45-8.55% taking comfort from OMO and extension if any will stay limited to 8.35-8.65%. The strategy is straight forward; to stay invested at 8.55-8.65% and not to stay “long” at 8.45-8.35%. It would be good to unwind longer end bonds with shorter end at similar yield, thereby creating room to absorb weakness into 8.55-8.65%. 5Y OIS rate is expected to maintain 100 bps spread with 10Y Bond yield to stay in consolidation mode at 7.45-7.55% with extension limited to 7.35-7.65%. The strategy is to stay paid on move below 7.45% and stay received on spike into 7.60-7.65%.

FX premium traded to the script as we chased 3M all the way to 6.75% and 12M into 4.9% from over 8.75% and 6.65% respectively. Now, market is in tight consolidation mode around 6.75% in 3M and at 4.90-5.20% in 12M. The interest rate play continues to favour upside momentum while exchange rate play is developing downside momentum. Given the deregulation in FCNR/NRE/Export Credit interest rates, FX premium should start aligning with corresponding money market rates to cut excessive arbitrage play between MM and FX yields. Let us watch consolidation in 3M at 6.5-7.5% and 4.90-5.40% in 12M. The strategy is to stay paid at 5.0-4.90% in 12M for eventual test/break of higher end into 5.75-6.0%.

Equity market

NIFTY is under pressure but holding above strong support at 4850/4825 but bounce from there is losing steam ahead of strong resistance at 4950/4975. In the meanwhile global bourses are also under pressure with DJIA unable to regain strong support at 12710-12735. Equity assets are not looking good despite attractive valuation and low P/E multiples with combination of weak domestic cues and uncertainty in external sector. Euro zone is looking vulnerable and investors are clearly on risk-off mode at this point of time. Given the near term expectation of downtrend in DJIA into 12220-12200 and absence of domestic investor appetite, FIIs will get into wait-and-watch mode with close watch on rupee. The immediate bias is for move into December 2011 low of 4531 on clear break of immediate support at 4775/4650. It would be good for strategic investors to buy in three lots at 4650/4500/4350 for short/medium term recovery into 5600. For now, let us watch 4500-5000 with bias into lower end. The strategy is to sell in two lots at 4900-4925 and 4975-5000 (with stop at 5025) for take-profit in two lots at 4675/4550.

Commodity market

Gold met its objective at 1525 (low of 1527) and now in consolidation mode at 1525-1575. The strategy of MARKET PULSE to stay “short” from above 1665 has been met. Now, the down move is yet to complete with next objective at 1485 and the near term range stands shifted to 1485-1585 from earlier 1520-1620. The test of 1485 should complete the big picture move from 1670. The strategy is to reinstate “shorts” at 1560-1585 with tight affordable stop for 1500; let us switch sides there by buying at 1495-1480 with tight affordable stop.

NYMEX Crude is in consolidation mode around $93. The strategy of MARKET PULSE to stay short from $110 has met the set objective at 93-95. Now, the near term range stands revised to 80-95 with bias into lower end. The strategy is to stay “short” by selling at 94-96 for 82-80. There are no cues at this stage to provide sharp reversal above $100.

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