MARKET PULSE: Weekly report for 14-18 May 2012
RBI seen very firm to defend rupee. Will it take operating control of the Rupee market?
RBI is seen firm to defend rupee and to prevent extended weakness beyond 54.00-54.30. The possible run into 56-57 was defended firmly on 15th December 2011 through measures that pulled foreign currency supplies from NRIs (interest rate deregulation) and cut dollar demand (strictures on FX operations). All these measures could provide stability within 52.50-53.50 till 9th January 2012; the rally thereafter to 48.60 (6th February) was driven by strong FII flows in January 2012 and supplies from NRIs to absorb high rupee interest rate of over 10%. The forward market was also in supply driven mode with 1-3M premium at 8-10% and 6-12M premium at 6.5-7.5%; so it is simple to conclude that rupee rally was led by supplies from FIIs (into capital account) and sales from exporters (into forward market) that drove the cash market into supply driven mode. Since then, rupee fell from 48.82 (29th February) to 53.92 driven by significant reduction in supplies into capital account (post-budget jitters) and forward market (low FX premium). RBI’s measures of restrictions in EEFC account and aggressive dollar sales have not yielded desired results with shallow correction into 52.95 for back above 53.50. It is now clear that reversal in rupee fortune has to be achieved by ensuring smooth inflow of funds into capital account and leading of supplies in forward market; two main sources of supply to bridge gap in cash market due to deficit in current account.
RBI has two options now, either to take operating control of the FX market or allow the rupee to find its own floor. RBI has done its best to “pull” inflows from NRIs by offering attractive returns and relaxation in terms for raising off-shore debt by resident companies. It is in Government’s domain to ensure smooth (and accelerated) inflow into debt/equity capital market from FII/FDI investors. RBI has now cut the flexibility available to companies to retain exchange earning to meet future payout obligations. Companies who have both imports and exports considered this product useful to cover exchange rate risk in cash flow mismatch between realisation and payout. There are some more that RBI could do: extend the tenor of import finance to 1 year and beyond; roll-back rules of outward remittances/investments available to resident individuals and companies; compulsory sale of foreign currency by exporters on post-shipment basis; allow conversion of FCNR into NRE deposit without incurring premature closure cost; lift cap on off-shore borrowing by Banks etc, but all these may not provide significant relief to rupee to guide trend reversal. It is possible that RBI would exert firm control over flows into cash market. What it could may be to provide direct cover operation to oil PSUs (thereby absorbing cash/forward dollar demand into its books) and referral of large value/single ticket demand from other companies before entering the market. This one-shot action (of removal of large value cash/forward dollar demand from the market) will send the cash market into supply driven mode with the option (for RBI) to cover their position at appropriate level in the market or absorb in its books (by release of dollars from its Balance Sheet and taking out rupees from the system). To make things simple, rupee can also be pegged to a particular range/band and revised on daily basis taking into account directional guidance from movement in USD Index/Euro.
What is the impact? It would be great relief for FX market (rupee appreciation in the near term) at the expense of Money Market (tight liquidity and high money market rates). It may not be good for Equity market as FIIs may prefer to exit when dollar is available at subsidised rate. In the absence of appetite from domestic investors, FIIs may choose to stay out till growth-inflation dynamics (and related conflicts) are sorted out. Obviously, it will open up a debate whether these measures are fair as it would hurt entities who adopt to prudent risk management practices. The impact of weak rupee on inflation is already diluted significantly with BRENT Crude down by 14% since March 2012 (from over $128 to $110) with good momentum for extension below $100. RBI with no clear intent on rate cut may need to go aggressive on CRR cut and OMO bond purchases, absorbing most of Government borrowing into its books. RBI is very firm to defend rupee but has no straight-forward options that can provide relief to rupee without hurting other asset classes. It is bad that the economy which was considering full Capital Account convertibility in 2000 is now back tracking to 1991 pre-liberalisation regime.
Currency market
Rupee recovery (post RBI’s measures and aggressive dollar sales) could not pierce strong support of USD/INR at 52.80 (low of 52.94) before close of week at 53.64; close above 53.35 is bearish for rupee. Given the strong bearish set up on rupee, there was good demand from importers to buy 2-3M forward dollars below 54 when spot rupee is at the risk of extended weakness beyond 54.30. What next? The undertone is clearly bearish driven by bullish USD Index (weak EUR/USD) and weak equity market. The attention is on RBI to prevent test/break of immediate resistance around 53.90 for quick extension into 54.30. The immediate support for USD/INR is at 53.35/52.95 where 2-3M forward dollars at below 54 will look cheap. On the other side taking comfort from RBI, there will be interest from exporters at 53.90-54.30 (3M dollars above 55). For now, let us watch 53.35-53.90 with extension limited to 52.95-54.30 tracking 3M forward dollars at 54.30-54.90 (with extension limited to 54.00-55.20). It would need strong measures from RBI to drive USD/INR into 52; lower end of set short term range of 52-57 and move below 52 is not in the radar now.
EUR/USD held well above strong support at 1.2900 (low of 1.2903) but inability to take out immediate resistance at 1.2960/80 for weekly close at 1.2915 is bearish into immediate term. The near term outlook for EUR/USD is bearish with target at 1.2625 (USD Index into 81.50-82.00); test/break of immediate support at 1.2875-1.2850 will be the first signal for this move. The risk to this expectation will be strong reversal above 1.3050-1.3075 (USD Index at strong support of 79.50); low probability at this stage. For the week, let us watch 1.2850-1.2980 with bias for test/break of lower end into first objective at 1.2750 ahead of 1.2625. The strategy is to sell in two lots at 1.2960-1.2985 and 1.3035-1.3060 (with stop above 1.3085) for 1.2775/1.2650.
USD/JPY was in tight consolidation mode at 79.70-80.00 with neutral bias into the near term. There is strong resistance in the 80.40-80.60 zone with strong support at 79.40 (ahead of 79.10). For the week, let us watch consolidation at 79.10-80.60 and stay neutral on break-out direction. The strategy is to play end-to-end by selling at 80.40-80.60 and buying at 79.30-79.10 with tight affordable stop. EUR/JPY is now in consolidation mode at 102.50-104.00 with immediate bias for test/break of lower end for extension into 101.50-100.00. The strategy is to sell at 103.75-104.25 (stop above 104.50) and buy at 102.75-102.50 (with stop/reverse at 102.25).
Interest rate market
Liquidity is tight with LAF drawdown above Rs.1 Trillion; RBI’s aggressive dollar sales have taken out rupees which also triggered start of OMO Bond purchases at start of FY13 (against expectation in H2/FY13). Money Market rates are up with 3-12M CD rates flat around 10%; rupee woes have unwound rate cut (of 17th April) impact with money market rates back into pre-rate cut levels. The economic data (IIP numbers) reaffirmed significant headwinds to growth momentum and moderation in inflation. This means that supply side pressures on inflation is diluted by release of demand push from low growth; however this will not be considered positive (and bullish) for the economy. The need is to maintain high growth and address supply side pressures through higher capacity to achieve moderation in core inflation. The way forward is complex; liquidity will be under pressure with RBI on over-drive to protect rupee and pressure on RBI to take growth supportive monetary stance. Our expectation of shift of system liquidity from deficit to surplus to drive operative policy rate to lower end of LAF corridor is not valid given the acute shortage of system liquidity. RBI would need to deliver CRR cut and continue with OMO operations to maintain LAF drawdown around Rs.1 Trillion. If RBI decides to absorb dollar demand from oil PSUs into their books, liquidity situation will turn worse. Taking all these together, 50 bps cut in CRR in the mid quarter review looks certain. Given these mixed signals, Bond market was in consolidation mode with 10Y Bond trading end-to-end of set range of 8.50-8.65% between set sell zone of 8.53-8.50% and buy zone of 8.62-8.65% before close of week at 8.56%. OIS rates too traded end-to-end of set weekly range of 8.0-8.10% (1Y) and 7.50-7.60% (5Y) before close of week at 8.05% and 7.53% respectively. The outlook into the near/short term is bearish on Money Market; there will be pressure on the shorter end of the curve while longer end of the curve supported by OMO, thus squeezing the tenor spread. For the week, let us continue to watch consolidation in 10Y Bond yield at 8.50-8.65%; 1Y OIS rate at 8.0-8.10% and 5Y OIS rate at 7.45-7.60%. It is important for RBI to keep OMOs in play to prevent extended weakness over 8.65%. Given the short term outlook of no rate cut and minimal impact from CRR cut, extended gains below 8.50% is not expected to sustain. The strategy is to stay “long” in 2 lots at 8.59-8.60% and 8.63-8.64% (with stop at 8.66%) for 8.52-8.50%. Strategic investors can cut the duration of the portfolio by selling long-dated bonds on 10Y yield move below 8.50% and shift to 1Y bond yield at 8.30-8.40%. Now, there is no incentive to play OIS from “paid” side; overnight MIBOR is not expected to go below 8.25% in the short term. The strategy therefore is to initiate pay in 1Y at 8.0-7.95% and in 5Y at 7.50-7.45% for back into 8.10% and 7.60% respectively which should hold. Fleet footed traders can run “receive book” in 1Y at 8.10% and 5Y at 7.60% for quick bucks into the lower end.
FX Premium eased nicely into the set objectives of 7% (3M) and 5% (12M) before close of week at 7% and 5.15% respectively; driven by strong exchange rate play. Now, RBI’s firm stance to defend rupee, there will be dilution in exchange rate play but would trigger interest rate play for upward bias into near/short term. There will be shift of demand from rupee liabilities to dollars given the upward pressure on 3-12M money market rate into 10%. Banks now have the leverage to price FCNR and Export Credit to cut this arbitrage. It is prudent to unwind “received” book (if not already done) and stay prepared to initiate “pay”. For the week, let us watch 3M at 6.75-7.5% and 12M at 5.0-5.5% and test/break either-way not expected to sustain. The strategy is to pay 12M at 5.15-4.90% (to convert FC sources) and receive 3M at 7.35-7.50% (to fund export credit).
Equity market
NIFTY maintained bearish undertone throughout the week for gradual fall from high of 5124 to low of 4906 before close of week at 4928; close below strong support at 4950 is negative. The move was in line with our view of looking for test/break of 4950 for extended run into 4775/4525/4350 in the near/short term. The domestic fundamentals continue to look weak driven by poor growth momentum (IIP data of 3% growth in FY12), weak rupee (risk of new low above 54.30) and tight liquidity (high LAF drawdown of over Rs.1 Trillion); all leading to lack of appetite from domestic investors. FIIs are in wait-and-watch mode and yet to come out of their shell despite deferment of GAAR and clarifications on other tax related issues. The Western bourses are also looking weak. It is less said the better for the Euro zone while economic data from the US is not bullish. DJIA mirrored NIFTY moves with gradual fall from weekly high of 13049 to 12748. It is important to hold above strong support zone of 12710-12735 to arrest import of bearish pressure on NIFTY. Given the absence of support from both domestic and off-shore investors, it is difficult to get into bullish undertone soon with low probability of appreciation to compensate for time value. It is possible that any correction during the week will face strong resistance at 4980/5040/5080; one of these levels will stay firm for test of 4765 and prepare momentum for move into December 2011 low of 4531 (ahead of 4280). This is the big picture at this stage. Having said these, there are positives in the pipe-line; Government will announce measures to attract off-shore investments and RBI will accelerate growth-supportive monetary measures. Strategic investors can stay away for entry of the first lot at 4775 having good appetite for more at 4575 and 4375; if all goes well, bullish turnaround can drive the NIFTY all the way to 5630 for a reward of 1000 pips. For the week, let us watch consolidation at 4825-4975 with bias into lower end not ruling out extended weakness into 4775. The strategy is to sell 4975-5025 (with stop above 5050) for 4775.
Commodity market
NYMEX Crude has now traded end-to-end of the set short term range of 95-110 for a gradual decline from the high of 110.55 to 95.17 (BRENT Crude down from 128.40 to 110.34); fall of 14% within two months’ time is good relief to the global economy. The reversal was guided by comfort from G3 (and OPEC) to arrest liquidity driven rally and sluggish global economic growth. There are no signs of reversal of the recent downtrend with short term target at 83.50-82.50 (BRENT Crude at 97). The short term range for NYMEX Crude is now at 83-98; possible correction into 98.50-101.00 will set up selling opportunities for strategic players. For the week, let us watch 88-98 with bias into lower end. The strategy is to stay “short” with stop above 98; if done, sell again at 99-101 (with stop above 101.50) for 88 (and 83).
Gold almost met its short term target at 1565 (low of 1573.20); sharply down from intra-week high of 1642. MARKET PULSE had highlighted the high possibility of shift of short term range into 1520-1620 with immediate objective at 1565. The downtrend in Gold is there to stay into the short term; test/break of 1565 will confirm move into the lower end of set short term range of 1520-1620 with possible extension into 1480 which should hold. For the week, let us watch 1520-1620 with bias into lower end. The strategy is to stay “short” with stop above 1600; if done, sell again at 1615-1625 (with stop above 1635) for 1525 (and 1485).
Have a great week ahead........................................Moses Harding
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