Weekly report for 2-6 July 2012

MARKET PULSE: Weekly Report for 2-6 July 2012

Currency market

The change of guard in the Finance Ministry and the reins into the hands of PM has indeed reversed rupee sentiment from bearish to neutral. Rupee held its weakness below 57.32 (all time low) to complete end-to-end move within the set near term range of 55.50-57.50. The reversal into 55.50 (high of 55.60) was swift driven by panic selling from exporters before close of week at 55.62. The swift move saw series of resistances at 56.40/56.15/55.85 taken out without any semblance of fight from the dollar bulls. The strong weekly close at 55.62 against previous close of 57.12 says it all. Exporters were seen running for “life” having missed above 57 with “fear” of run-away extended rupee gains into 54-52. Now, it is important for the PM to “undo” the factors that triggered rupee fall to regain bullish confidence on the rupee. Rupee was indeed trading comfortably at 48.50-49.00 (pre budget high of 48.60) till release of Budget FY13; post-budget disappointment pushed rupee sharply down to 55 into mid quarter June Monetary Policy review (pre policy high of 54.92); disappointment in the monetary policy pushed rupee further down to over 57. There was also a “minor” disappointment last week on delivery (of reforms) much below expectations but there was quick damage control to prevent posting of a new all-time low above 57.32. Over all, disappointment from the Budget and fear of delay in shift into growth supportive monetary policy is seen as major factors that lead to rupee fall from 48.60 to 57.32, and the need now is to get the rupee back to 48.60 through delivery of expectations that would address major issues relating to Capital Account flows and twin deficits, thereby removing the risk of extended stagflation of the Indian economy. What next? As Phase I, it is important to provide 100% unwind of rupee losses from its pre-monetary policy high of 54.92 to post-policy low of 57.32. The “unwind” journey has already completed two-third of the distance in quick time and it is matter of one trading day to hit 54.92. Beyond there to begin the Phase 2 of the journey from 54.92 to 48.60, it would need roll-out of next generation reforms attracting long term capital account flows into core sectors of the economy and release of pressure on fiscal deficit through roll-out of price hike in diesel, kerosene and cooking gas. The ability of the Government to get political consensus to these critical issues is in doubt at this stage. However, there is confidence that Opposition parties will extend support (on issue based basis) during this crisis period to prevent the worst on the economy. These actions from the Government will provide comfort to RBI for shift into growth supportive monetary stance. The strategy of MARKET PULSE was to sell 3M – 10Y dollars on extended rupee weakness above 57.00 and asked importers to await reversal into 54.00-52.50. Why beyond 3M? While the near term outlook is uncertain which could have extended rupee weakness into 57.90-58.50, short/medium/long term outlook for rupee is bullish. Rupee is grossly undervalued (above 57) to sustain there for long. The sharp reversal in Crude and commodity prices is very good news for India and possibility of medium/long term sustainability of commodity prices at current levels is strong given the current weak state (and health) of global economy and favourable geo-political developments. The flow of external liquidity and capital into India will be there to stay for long period as western economies are not expected to get into aggressive growth momentum till 2014-2015 if not beyond. India will remain as attractive destination if GDP growth can be maintained at 6-7%. The pressure will be on exports (and Current Account Deficit) which could be addressed through reduction in non-essential imports; lower consumption of essential imports and roll out next-generation export reforms across sectors with long term vision to turn surplus in Current Account. Till such time, Balance of Payment position is not expected to turn “deficit” as flows into debt and equity capital market will be ensured to meet deficit in current account; hike in FII limit for investment in Gilts by USD 5 Bio is case in point. For the week, let us watch 54.00-55.50 with bias into lower end but extended gains below 54.00 (into 52.95) is not expected to sustain till the Government walk the talk. It will be good to unwind part of “short” June 2013 dollars at 57.25-57.00 (against entry at 60.00-60.50). It is also good for importers to cover 1-3M imports (September 2012 dollars at value below 55). If all goes well on delivery of expectations from the Government and RBI, rupee should get into consolidation mode at 51-54 into the short term.  

EUR/USD held well at the solid support/buy zone at 1.2425-1.2450 (low of 1.2405) and reversal from there hit the first objective set at 1.2700-1.2750 (high at 1.2692) before close of week at 1.2660. In the meanwhile USD Index lost steam above strong resistance at 82.60 for back into 81.50. The expectation into the EU summit was low but delivery beyond expectation brought “awe” feeling into the market to drive the USD Index down as investors turned into “risk-on” mode. The next target for EUR/USD is at 1.2875-1.2925 (not ruling out extended run into 1.3050-1.3100) while 1.2600-1.2550 stays firm. USD Index is also expected to extend its weakness into strong support zone at 81.20-80.90 (ahead of 80.50/79.65). For the week, let us watch 1.2600-1.2900 with bias into higher end, not ruling out extended gains into 1.30. The strategy is to stay “long” at 1.2625-1.2575 (with stop below 1.2550) for 1.2825/1.3000.

USD/JPY lost steam above strong resistance at 80.50 (high of 80.59) but sharp reversal from there held above strong support at 79.10 (low of 79.14) before close of week at 79.77. Ideally, this currency pair should remain weak while 80.50-80.75 resistance zone stays firm for test/break of 79.10 into 77.75 ahead of final objective at 76.00-75.50 before sharp reversal. For the week, let us watch 79.00-80.50 with bias into lower end, not ruling out extended weakness into 78.50-77.75. The strategy is to sell at 80.25-80.75 with tight affordable stop for 79.15/78.65/77.65. In the meanwhile, EUR/JPY was volatile within strong support at 98.50 (low of 98.30) and strong resistance at 101.60 (high of 101.39) before close of week at 101.02. This currency pair is giving bullish signals for extended gains above 101.60 into 103.25. The strategy is to stay “long” at 100.50-100.00 with stop below 99.75 for 103.00-103.25.

For better hedging/trading results, watch intra-week updates on Twitter (@mosesharding)     

Interest rate market

There was not much of change in liquidity position and MM rates. The action was in the Bond market where opening up $5 billion demand from off-shore investors and resultant absence of OMO drove the 10Y bond yield into higher of set short term range of 8.0-8.20%. We considered gains below 8% was excessive and asked to unwind investments there (saw low of 7.95%) for reinvestment at 8.18-8.23%. The end-to-end move from below 8% into 8.20% was swift. This goes to validate our stance that without OMO support, supply side concerns and delay in rate cut action will send the market into bearish mode. OIS rates also stayed bid; 1Y moved up from 7.72% into the set receive zone of 7.80-7.83 (high of 7.81%) and 5Y up from 7.12% to 7.22%; end-to-end of set pay zone at 7.15-7.12% and receive zone of 7.22-7.25%. What next? 10Y Bond yield above 8.20% is good to stay invested into the short/medium term. It is now possible that RBI will prepare for shift into growth-supportive monetary stance either through rate cut or guiding the policy rate from Repo to Reverse Repo rate through aggressive liquidity injection through combination of CRR cut and OMOs. The worry on inflation will stand diluted on sharp recovery in BRENT Crude and Rupee, which should build expectation on monetary action in July quarterly review. 1Y OIS rate will look heavy at 7.80-7.83% for reversal into recent low of 7.45% while 5Y stays in consolidation mode at 7.10-7.25%. The play will be in the 1X5 spread for spread squeeze from 60 bps to 35 bps in due course. For the week, let us watch 10Y Bond yield at 8.10-8.25%; 1Y OIS rate at 7.70-7.85% and 5Y OIS rate at 7.15-7.25%. There will be marginal upward pressure on OIS rates on tight liquidity into new reporting fortnight cycle but test/break higher is not expected to sustain. The strategy is to stay received in 1Y at 7.81-7.84% (stop at 7.86%) and receive 5Y OIS at 7.23-7.28% (stop at 7.31%) for 7.70% and 7.15% respectively. It is good to rebuild long tenor investment on extended weakness in 10Y Bond into 8.20-8.25%. This will also activate Bond spread trade for minimum 1% “carry” between 10Y Bond yield and 5Y OIS rate.

FX premium extended its bull run into 7.5% (3M) and 6.0% (12M) before close of week around 7.25% and 5.75% respectively. We asked to unwind 12M paid book at 5.85-6.0% and switch side to stay received. The long “chase” in 12M premium from 4.5-4.25% is now complete at 5.85-6.0% and it is time for reversal to unwind part of the recent rally from 4.25% to 6.0% with immediate target at 5.25%. The forward market has gone into aggressive supply mode; exporters are in a hurry having missed the spot move above 57 and on the fear of spot rupee travel back to 54-52 soon. On the other hand, interest rate play will turn favourable for sharp down move as RBI prepares for shift of operative policy rate from higher end to lower end of LAF corridor. For the week, let us watch 3M at 6.75-7.5% and 12M at 5.25-6.0% with bias into lower end. The strategy is to stay received in 3M at 7.35-7.5% and in 12M at 5.85-6.0% for 6.80% and 5.35% respectively.

Equity market

NIFTY traded perfected to the script, initial weakness held well at set buy zone of 5100-5075 (weekly low of 5095) for rally into weekly objective at 5275-5300 (high of 5286) before close of week at 5279. Most factors have turned bullish for equity market; western economies are in heavy stimulus to maintain bullish undertone into the short term (if not into long term) and domestic cues are looking good with PM at the helm of economic and monetary activity. It is believed that all recent disappointments will be addressed on issues related to capital account flows, fiscal deficit and growth. This should also lead to global rating agencies taking a favourable stance on India. Now, the target is at the pre-budget high of 5630 having regained most of sharp fall to post-budget low of 4770. For the week, let us watch 5200-5450 with bias into higher end and prepare momentum for extended gains into 5630 in due course. The strategy is to hold on to “longs” (entered at 5100) and add at 5250-5200 (with stop below 5175) for 5425-5450 and 5600-5625.

Commodity market

It was volatile week; first down from resistance at 1690 (high of 1588) to 1547, but post EU Summit rally was strong for solid run into 1606 before close of week at 1598. It is bullish close as investors are into “risk-on” mode, thus driving the dollar weak with support to risky assets. Now, the momentum is good to provide extended gains into 1635-1640 ahead of 1670 while 1585-1565 stays firm. For the week, let us watch 1565-1670 with bias into higher end. The strategy is to stay long on correction into 1585-1565 with tight affordable stop for 1635/1670.

The post EU Summit rally in commodity prices pushed NYMEX/WTI crude into higher end of set short term range of 75-85 (high of 85.34) from weekly low of 77.28 before close of week at 84.94. In the previous weekly report, MARKET PULSE had highlighted the risk of correction into 85-90 having achieved the short term objective above 75. The impact of “risk-on” mode will be limited on Crude price with low confidence on global economic recovery. The EU zone is safe into short term but that does not mean reversal into economic growth. The sharp reversal from 77 to 85 can be seen as “short squeeze” which should not extend beyond 90 in the worst case. We continue to maintain short term range play at 75-90 with test/break either-way not expected to sustain. For the week, let us watch consolidation at 80-90; immediate bias into higher end would set up short term selling opportunity into 78-75. The strategy is to sell at 88.50-90.50 (with stop at 91.00) for 78.

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

Short term perspective on markets

Combination of disappointment and hope....mixed signals but weak on confidence

The initial recovery in rupee into 56.38 got completely unwound for reversal into 57.10 post release of measures; obviously the delivery was not to expectations. The first worry was from FM passing on the baton to RBI for announcement. It was not expected from RBI measures other than relating to DCM (Debt Capital Market). RBI did its best to enhance limits; review of operative restrictions and increased the pool of investors. Yes, it is positive but seen as too little given the large appetite. The hope ahead is that more measures will follow relating to ECM (Equity Capital Market) such as roll-back of tax related issues; open-up sectors for long term sustainable flows and broad base the pool of investors. The expectation of USD 15-20 billion foreign currency Bond issuance for subscription by NRIs and other eligible investors is warm. More importantly, the market also awaits action on fiscal consolidation. The near term will be action packed and it is essential that new FM delivers to expectations. If the Finance Ministry is retained by PM, then it will add to confidence.

The play is now between “shock” and “awe”; any shocker will get the rupee focus into 57.90 ahead of 58.25-58.50 while exceeding expectation will quickly revive rupee bullish trend into 55.50 ahead of 54.00. As said, rupee level at 57.00-58.50 takes into account all negative factors but positive factors (mainly from sharp fall in crude oil and resultant release of significant pressure on CAD) are  yet to be counted in. The lack of confidence and no clear bottoming out signals is causing delay to shift the forward market into supply driven mode despite highly devalued rupee; exporters need to get the fear of sharp reversal in rupee into 54-52 to open the flood gate for dollar supplies. The short term range for rupee is now seen at 54-57 and extension not beyond 52.50-58.50. The strategy is obvious; exporters can look to hedge medium to long term receivables (3M and beyond) on spot weakness into 57.00-58.50. For those who look for interest cost reduction on long term loans, spot rupee at 57.00-58.50 is good to convert 3/5/7 year rupee loan to foreign currency (and can look to cover the first year on rupee move into 54.00-52.50). There is no need for importers to panic on payables/liabilities beyond short term (up to 3M) and can afford to stay aside for rupee bullish reversal into 54.00-52.50.

Higher limit for foreign investors in Gilts will address supply-side issues and reduce OMOs

The enhancement in investment limit in Gilts by USD 5 Billion for foreign investors will be absorbed immediately. The risk-reward is greatly in favour of the investment given the possible shift into accommodative monetary policy (and rate reversal cycle) sooner than later. Believe, there is enough room for further enhancement of limits; seen as simple form of pulling dollar supplies to USD Bond issuance with sovereign guarantee (underlying credit exposure and the yield are more or less the same). It gives room for RBI to reduce its OMO operations and instead resort to CRR cut for liquidity injection. These expectations into the future will drive the Bond/OIS market into consolidation mode and it is time to build steepness in the yield curve to factor time value; downward push in the shorter end (1-3 years); moderation in the medium tenor (3-12 years) and uptrend in the longer end (beyond 12 years). It is also possible that next monetary action may not be from rate cuts but from shifting the operative policy rate from 8% to 7% and shift the yard stick to 1% NDTL surplus system liquidity. The “play” will be in the shorter end with 1Y Bond yield down to 7.75% and 1Y OIS rate around 7.5%. The chances of movement in 10Y yield below 8% and 5Y OIS rate below 7.10% is low and if it does, it will considered good to conduct “Operation Reverse TWIST”; buy short and sell long. The strategy may be to maintain short duration in the investment book keeping enough room for absorption of supplies from RBI as move into rest of FY13. On the other hand, 10Y Bond yield at discount (8.15-8.25%) will look good for medium/long term play when RBI gets into rate cut mode beyond 2012 if inflation is tamed by then and GDP growth stays at 5-6% zone.

Improvement in domestic cues to shift equity market into bullish undertone

The domestic equity market has strongly withstood recent disappointments, third in a row from the Union Budget, mid quarter review of monetary policy and now. It was surprise to many who looked for sharper correction into 4800 in NIFTY but held strong above 5075-5100 support zone. It is matter of time that the Government will undo the disappointments from Budget FY13 on issues related to GAAR and retrospective tax treatment. It is also expected that there will be roll-out of next generation reforms in part if not in full. The act into fiscal consolidation and RBI’s shift into growth supportive stance will address growth and fiscal deficit related concerns of rating agencies. UPA will gear up to maintain positive (and favourable) mood before 2014 elections. Over all, concerns related to Government policy paralysis and twin deficits may be out of the way to shift focus on growth and inflation. The external environment is uncertain but loose monetary policy of Western economies and relatively stronger Indian economy will retain India as good and safe-haven investment destination. It is also essential to enhance access to those foreign entities that are eligible to invest in DCM. The undertone will turn bullish sooner than later. It is safe to assume that short term target is at 5630 to complete 100% unwind of recent fall from 5630 to 4770 (22nd February 2012 to 4^th June 2012). If all goes well to enable RBI to shift into loose monetary policy stance (like rest of the Central Banks), medium term target will be at 5950-6350. Let us give up this bullish expectation on any disappointment driven fall below 4775. It would be good risk-reward for strategic investors to stay in preparedness to absorb weakness into 5100-4800.

Good luck..........................Moses Harding

Weekly report for 25-29 June 2012

MARKET PULSE: Weekly report for 25-29 June 2012

Operation “Reverse TWIST” can restore confidence for short term rupee target at 52

It was an eventful week and one of the worst for rupee. It started with post-monetary policy disappointment, followed by FITCH downgrade of sovereign rating outlook from stable to negative, FOMC delivering to expectations reaffirming its near zero interest rates stance till 2014 and extending “Operation TWIST” to end 2012 with financial package of $267 Billion. ECB also extended and reaffirmed financial support to Euro zone through purchase of sovereign bonds in the secondary market and funding support to Banks. The disappointment for many was from RBI’s pause mode and hawkish monetary stance and to some on non-delivery of QE3 by the FED. The impact on asset markets was neutral except for sharp fall in rupee exchange rate. Rupee fell sharply from pre-policy high of 55.26 to post-policy low of 57.33 before close of week at 57.12. In the meanwhile, BRENT Crude fell sharply from weekly high of 99.50 to low of 88.49 before close of week at 90.98. The downtrend in commodity prices is to expectations despite loose monetary policy. Commodity prices are sharply down in 2012 on lack of confidence into the future tracking loose fiscal policy and recessionary/stagflation trend in the Global Economy. China is also showing signs of deceleration in growth momentum and Japan is into Current Account Deficit mode. The expectation of support from the EDM group (Emerging and Developing markets) to the global GDP is under threat. There is no risk of sharp reversal in commodity prices and expected to stay in consolidation mode (with mild downward bias) till signals of global recovery is sighted, which seems to be distant away. This will be good for economies importing crude oil and run Current Account Deficit while it is serious threat for oil exporters who have enjoyed extended run since 2008.

Rupee’s fortunes depend on the ability to address issues relating to growth, inflation and twin deficits in fiscal and Current Account. The fear of CAD (as risk to rupee) is now out of the way on sharp downtrend in commodity prices with possible 30% cut in the oil import bill in dollar terms. It will be good if Oil Marketing Companies look to hedge FY13 imports on extended weakness in BRNET into $75-85. It is also possible that weak rupee will reduce non-essential imports and reduce consumption of essential imports, thus expected to release pressure on the demand side of CAD. It is also possible that highly overvalued rupee will help exports into the short/medium term. The twin advantage for rupee at this stage is the release of pressure on CAD and highly over-valued USD. Why bearish set-up on rupee? There are two reasons: one, weak macro fundamentals and fear of sovereign rating downgrade and the other is the accounting issues related to hedging of export contracts; one leading the dollar demand and the other lagging dollar supplies causing severe pressure on an otherwise dollar demand-driven market. Most exporters who have covered dollar receivables for FY13 (at spot 44 to 52) are at risk of huge mark-to-market provision in their quarterly results. It is now a trade-off between taking a P&L hit or buy highly undervalued forward rupee; most prefer to protect P&L to covering exchange rate risk when there are no signs of bottoming out signals of rupee weakness. Most exporters end up providing opportunity loss in the P&L account. On the other hand, real losses from uncovered import (and FC liability) exposures are directly taken into the top-line only on maturity of the exposure while mark-to-market losses are ignored.

The risk of rating downgrade emanates from the fear that unless the system shifts to favourable monetary dynamics, issues related to growth and fiscal deficit are difficult to be resolved. It would be worse with unfavourable political and external environment. It would also need stable (and strong rupee) to get the benefit of weak commodities on inflation. The benefit from sharp fall in BRENT Crude from $126 to $99 since Euro zone crisis is completely undone by fall in rupee from 44 to 57. Indian economy stands out in its monetary stance while others are into excessive loose monetary policy to arrest recessionary trend and deceleration in growth. The issues of high Current Account Deficit and high inflation is also unique for India and with this disadvantageous position, it is hard to get into the right side of rating agencies. It is necessary to shift into accommodative monetary stance to provide comfort on growth and fiscal deficit. There is strong linkage between growth and fiscal deficit and growth issues have to be addressed first to get into fiscal consolidation.  RBI is not expected to get into rate cut mode till headline (and expectation on) inflation turn favourable. FED supports the US monetary system through “Operation TWIST” (after exhausting options on rates and direct liquidity through QEs) by selling short bonds and buying long bonds to arrest spike in long term yields at the cost of marginal spike in the shorter end. The scenario in India is different; shorter end of the rate curve is up with a downward slopping to flat in the mid to longer tenor. The need is to exert downward pressure in the shorter end and provide stability (with marginal upward bias) in the mid to longer end to make rate dynamics supportive to growth without rate action. It could be done by liquidity injection through CRR cut and OMO bond purchases or “Operation Reverse TWIST”; buying bonds in the shorter end and selling in the longer end. If this action is followed by guidance on shift in operative policy rate from Repo rate to Reverse Repo rate through shift of stance by RBI to maintain system liquidity in surplus mode within 1% of NDTL, there will be significant squeeze between overnight MIBOR and 1-2Y Bond yield. It is all about confidence and bullish expectation into the future and it is difficult in the absence of growth supportive monetary policy. This could provide trend reversal in rupee from above 57 to below 52.

Currency market

Rupee weakness moved past the higher end of the range at 57.15 but fell short of the stop/reverse set at 57.35 (low of 57.32) before close of week at 57.12. Rupee lost its traction with USD Index post monetary policy; while EUR/USD moved up from 1.2550 to 1.2750 and back at 1.2550, rupee was in one-way move from 55.26 to 57.32. Ideally, rupee should have extended gains below 55.25 (on its reversal from 56.52) to 54.50 (tracking EUR/USD from 1.2550 to 1.2750) and should have been in consolidation mode around 55 in the worst case. But now it is above 57 and that is the kind of bearish set up on rupee with dollar demand over-run in the market. What next? Rupee is highly overvalued and 30% fall in BRENT Crude has to get factored in rupee exchange rate. There is no risk of reverse flow in capital account but for pipe-line FCCB repayments. It is important for RBI to prevent the worst and engineer sharp unwind of recent fall from 54.92 to 57.33 (since 7^th June to 22^nd June) to get the rupee bulls on street. It is now believed that RBI is alright with weak rupee if it could support addressing issues concerned with CAD, in which case, the next downside targets for rupee is at 57.90 ahead of 58.25-58.50. The immediate support for USD/INR is at 56.75 (ahead of 56.40) and further into 55.85-55.50 which could be a strong near/short term base for the pair. For the week, let us watch 56.40-57.90 with extension limited to 56.15-58.25. The strategy is to buy 1-2M payables on rupee gains into 56.40-56.15 and sell long term dollar receivables on extended rupee weakness into higher end. 7Y forward dollars at value above 80 (current at 77.50-78.50) is good to convert rupee liabilities into foreign currency. For today, rupee is expected to stay in consolidation mode at 56.75-57.35 and would prefer test/break of lower end into 56.40-56.15.

EUR/USD nicely played end-to-end of 1.2525-1.2500 (low of 1.2518) buy zone and 1.2725-1.2750 (1.2747) sell zone before close of week at 1.2568. It was a perfect “buy the rumour; sell the fact” syndrome as pre FOMC rally to 1.2750 was completely unwound post FOMC. However, FED’s stance of keeping QE3 expectations warm provided support to EUR/USD above 1.25 to prevent extension into 1.2250. What next? In the absence of any negative cues this week, EUR/USD is expected to hold above strong support at 1.2425-1.2450 with marginal bias for test/break of 1.2750 into 1.29. For the week, let us watch 1.2500-1.2750 with bias into higher end not ruling out extended gains into 1.2850-1.2925. The strategy is to buy on dips into 1.2525-1.2450 (with stop at 1.2425) for 1.2725/1.2875. It is also good to sell at 1.2875-1.2925 (with stop above 1.2950) for 1.2525-1.2475.

The reversal in USD/JPY from 79.75 found support above 78.75 for extended rally into 80.50 before close of week at 80.40. The widening Current Account Deficit in Japan and negative outlook on Chinese growth momentum will keep the JPY weak both against USD and EUR. For the week, let us watch USD/JPY at 80.00-81.75 with bias into higher end. The strategy is to buy at 80.25-79.75 (with stop at 79.50) for 81.50-81.75. EUR/JPY too has rallied sharply from 99 to over 101 and looks good for extended gains into 103.25-104.25. The strategy is to trade end-to-end of 100-104 with tight stop on break thereof.

Interest rate market

It was volatile week in the Bond market. 10Y Bond yield was sharply up from pre-policy low of 7.95 for post-policy weakness into 8.20% before down again to 8.0% on OMO support before close of week at 8.09%. It was a nice end-to-end move within 8.0-8.20%. Our strategy to unwind long on extended gains into 8% and stay invested at discount has proved good. The outlook is neutral to negative and sharp gains in 10Y Bond into 8% will be stretched, hence not expected to sustain. On the other side, there is risk of extended weakness beyond 8.15-8.20% if RBI decides to cut bearish outlook on markets with surprise CRR cut (and “Operation Reverse TWIST”). For the week, let us watch consolidation at 8.0-8.20% with test/break either-way not expected to sustain. The strategy is to trade end-to-end and stay invested at 8.18-8.23% for short/medium term rally post downtrend in headline inflation.

The monetary policy disappointment drove 1Y OIS rate up from 7.54 to 7.86 before close of week at 7.77% while 5Y rate was up from 7.17 to 7.36 before close at 7.20%. What next? There is more clarity in the 1Y as the bias is for move into pre-policy low of 7.45% while move into 7.85-7.90% will set up good receiving opportunity. The focus will now shift to 1X5 spread play to squeeze the 1X5 spread below 50 bps (which is currently in consolidation mode around 55 bps). On the other hand, 5Y OIS rate below 7.15% is tough to hold for gradual push into 7.35-7.40%. For the week, let us watch 1Y at 7.55-7.80% and 5Y at 7.15-7.35%. The strategy is to stay received in 1Y at 7.78-7.83% (with stop above 7.85%) for 7.55-7.45% and pay 5Y at 7.15-7.10% (with stop below 7.08%) for 7.33-7.38%.

FX premium eased from recent high of 7.25% (3M) and 5.75% (12M) for close of week at 7% and 5.4% respectively driven by exchange rate play tracking sharp spike in USD/INR above 57. What next? The interest rate play will turn bearish to exert downward pressure and the directional guidance will be from exchange rate movement. Given the risk of extended weakness in rupee into 58, bias can be lower but sharp reversal into 55.50 and beyond in the near term will keep bullish trend intact. It is important for FX premium to stay at elevated levels till rupee fears are completely out of the way. For the week, let us watch consolidation at 6.50-7.25% (3M) and 5.25-5.75% (12M). The strategy is to play end-to-end and test/break either-way is not expected to sustain.

Equity market

NIFTY retained its pre-policy rally into post policy (despite disappointment) for push from 5041 to 5170 before close of week at 5146. In the meanwhile, DJIA fell from intra-week high of 12899 to 12561 before close of week at 12640. The rating downgrade of Banks and FED delaying the roll-out of QE3 caused bit of damage for US markets. NIFTY weekly close above 5075-5100 support is bullish but inability to take out 5175-5200 is a concern. Having said these, it is indeed a pleasant surprise for NIFTY to stay here despite weak rupee, hawkish monetary stance, risk of sovereign rating downgrade and general lack of confidence on the Indian economy in the short term. The global bourses will get into consolidation mode in the near/short term on strong stimulus support but medium/long term outlook is suspect. A nice trading range is set in DJIA at 12000-13500 with bias into higher end. The June rally in NIFTY from 4770 to 5190 was superb despite sharp fall in rupee from 54.92 to 57.32; hawkish monetary stance and delivery of rating watch by S&P and FITCH. The reason for sustainable rally could be sharp downtrend in BRENT Crude which will be a great advantage for India into the medium/long term while aggressive injection of liquidity in Western economies and highly undervalued rupee attracting FII interest. The momentum now looks good for extended gains over 5200 to get the focus into 5300/5450 while 5100-5075 stays firm. For the week, let us watch 5100-5300 with bias into higher end. The strategy is to buy dips into 5100-5075 (with stop below 5050) for 5275-5300. It is not clear at this stage whether NIFTY could extend its rally into 5630 to complete 100% reversal of recent fall from 5630 to 4770.

Commodity market

It was a perfect “buy the rumour and sell the fact” action; pre FOMC rally from 1525 to 1640 reversed sharply post FOMC into 1558 before close of week 1571. It was also disappointment for the commodity market not to see the roll-out of QE3. So, it is back to consolidation at 1525-1640 with bias into 1500-1475 before sharp reversal. There is no change in view of formation of strong base at 1525-1475 for strong short term rally. For the week, let us watch 1525-1590 with bias into lower end. The strategy is to stay short for this move for lower end to complete end-to-end of set near term range of 1525-1640.

NYMEX Crude almost hit the set short term objective at 75 (low of 77.56) before close of week at 79.76. We may need to allow for bit of consolidation after this strong move from 110 to 77 before possible visit to 65 which is seen as strong short/medium term base. For the week, let us watch consolidation at 75-85 with test/break either-way to attract. The strategy is to sell at 83.50-85.50 (with stop at 86.00) for 75.50. NYMEX Crude price has discounted the global economic gloom but there is risk of bullish reversal into 90 on QE3. But, not expected to move beyond 90 to set up a short term range play at 65-90. After a $30 chase from over 110 to below 80, need to stay prepared for the next $20-25 chase from 90 to 65.

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

         

MARKET PULSE: 21 JUNE 2012

MARKET PULSE: 21 June 2012

RBI struck between stake holders’ expectations and Governments’ policy inaction

It is the first time the market has seen such a strong defence of monetary actions by the Governor. At the outset, RBI is indeed not in an enviable position during these crisis days to deliver expectations from the stake holders without minimum support from the Government. It becomes worse when the external sector turns excessively adverse exerting strong headwinds diluting the impact of monetary actions. This time, Industry and financial markets expected 50 bps CRR cut based on spike in drawdown from LAF counter to over Rs.1.25 Trillion on run into policy day. This was seen to be extremely high as against RBI’s tolerance level of 1% of NDTL (around Rs.60K Crores). There was also precedence of delivering 75 bps CRR cut ahead of policy day when drawdown from LAF counter exceeded Rs.1.5 Trillion. Although RBI prefers OMO for liquidity injection, it is liquidity neutral to cover week-on-week bond supplies from RBI. The major beneficiary of OMOs is the Government, to keep cost of borrowing at administered affordable rate. The expectation of 50 bps CRR cut obviously did not have linkage to any economic data. Moreover, current CRR of 4.75% is seen to be at higher end of 3.0-6.0% band with room for downward revision. The industry also expected 25-50 bps rate cut based on downtrend in core inflation print below 5%, weak IIP data of near zero percent growth and shocker from Q4FY12 GDP growth of 5.3%, and considered downside risks to growth is more severe than upside risks to inflation. This being the base numbers for FY13, it is seen as impossible for the Government to achieve the set ambitious targets for FY13. It is also seen that MM Sovereign yield curve is inefficient with 1Y yield below 10Y yield, thus not building the time value, with the need to build steepness in the curve by guiding the 1Y yield down. There are no signals to look for sharp reversal in interest rates to validate the inversion in the yield curve. There is no significant impact on MM rate curve since delivery of 50 bps rate cut in April because of elevated overnight rate at higher end of LAF corridor. It also looks difficult at this stage to shift system liquidity from deficit to surplus to get the benefit from shift of operative policy rate from Repo to Reverse Repo rate. The combination of these factors built strong expectation of 25-50 bps rate cut by the Industry and entire financial market participants. Moreover, current operative policy rate at 8% is seen to be trading at higher end of 4.0-9.0% acceptable band with good room for downward revision. Therefore, it is fair to conclude that the expectation from the Industry and financial market participants was genuine, thus the post-policy disappointment!   

What went wrong? The issue is between the Government and the RBI. It is true that RBI cannot shift into dovish monetary policy stance when headline inflation is at elevated levels. There seems to be no resolutions to many critical factors. The common man is concerned about high food price inflation. While this cannot be controlled from demand side, there is little action from the Government to address from supply side and through administrative efficiency. It is less said the better on fuel price inflation as it stays administered with high subsidy content. The food and fuel price inflation print will move up on roll-out of minimum support price on agriculture commodities and price hike in diesel, kerosene and cooking gas. The other major concerns of RBI which have direct relevance to monetary system are from fiscal deficit and Balance of Payment. The impact of these is felt on rupee liquidity, flight of rupee capital, exchange rate instability and upward pressure on interest rates. It is impossible for RBI to control inflation with high fiscal deficit and weak rupee. RBI wants to see tangible actions in pass-through of subsidy cost; measures to bridge Current Account deficit and reforms to attract sustainable long term flows into Capital account. It is believed that unless these structural issues are resolved, shift into dovish monetary stance may not be effective to support growth.

What next? The resolution to this growth-inflation conflict obviously is in the hands of the Government. It will be a long-drawn process but the first step needs to be taken quickly with political consensus. It is not that the Government is not aware of these critical needs; the issue is in its execution capability (and/or limitation) to bring the coalition partners together. There is no guarantee that parties outside UPA will extend support to Government on these agenda. The fragmented political mandate is seen as the curse for the Indian economy; Government is unable to bite the bullet on fear of opposition from other political parties or has deep pockets to absorb costs. It is crisis time and it is essential for the Congress Party to manage support within and outside UPA to roll-out next generation reforms to attract off-shore liquidity and capital and get into the act of fiscal consolidation. The economy runs the risk of sovereign rating downgrade to junk status by global rating agencies. We may not accept it but lenders and investors will take note of it and move away from the storm. It will be catastrophic on asset markets; weak rupee, high bond yields and weak equity market will kill the investor confidence on the Indian economy. The concerns from the rating agencies are on political governance, fiscal consolidation, growth, inflation, balance of payment, exchange rate stability and so on. The Governor can rest assured that the Industry and financial markets will be with RBI to exert “pressure” on the Government to get their acts right to get the economy back on track.      

What is the take-away? It is possible that RBI will be into an extended pause mode. The headline inflation (wholesale and retail) will stay high and inflation adjusted borrowing cost will be low, not considered as major risk to growth. There will be added pressure from external sector as FED/ECB/BOE starts roll-out of next round of stimulus measures, seen as inflationary for India. There is lot to do for the new FM to bridge gap between expectations from RBI and execution capabilities of the UPA. The other stake holders of the economy have no option but to wait and hope for the best!

Currency market

Rupee traded 55.82-56.16 within immediate support at 56.18 and resistance at 55.75 before close at 56.15. The unfortunate part is that post-policy bearishness on rupee could not take the benefit of sharp rally in EUR/USD into 1.2750. What next? FED delivered to expectations; provided guidance to maintain policy rate at near zero level till 2014 and extended Operation Twist into rest of 2012. This can be considered as neutral for the USD and USD Index is expected to stay within 80.50-82.50 range. No QE3 is a disappointment but most participants expected this liquidity injection in the last quarter of 2012. Let us continue to stay tuned to the set near term range of 55.75-56.50 with extension limited to 55.50-57.15. The extended weakness into 56.90-57.15 will attract good supplies from the market. Spot rupee around 57 will be too stretched, hence considered good to sell 12M receivables (at value above 60) and shift 3-10 years rupee liabilities to USD. For now, let us watch 55.85-56.50 with bias into higher end. The strategy for exporters is to sell 3M/September dollars above 57.50 (spot around 56.50); 6M/December dollars above 58.50 (spot around 56.75) and 12M dollars above 60 (spot around 57).

EUR/USD traded end-to-end between sell zone at 1.2725-1.2750 and buy zone at 1.2575-1.2550 (high of 1.2743 and low of 1.2567) and into consolidation mode at 1.2650-1.2750 post FOMC. There is no big-bang from the FED but has delivered to expectations to provide post-FOMC price stability. Now, the focus is into the Euro zone. We retain the near/short term bullish outlook on the dollar and would allow bit of consolidation till dust settles down. For now, let us watch consolidation at 1.2550-1.2825 with test/break either-way to attract. The strategy is to trade end-to-end of this move by selling at 1.2775-1.2825 (with stop above 1.2850) and buying at 1.2575-1.2525 (with stop below 1.2500).

USD/JPY rallied from immediate support above 78.75 but could not take out resistance at 79.75 (low of 78.77 and high of 79.67) and runs the risk of extension into 80.25-80.50 before down. The short term trend below 78.75 into 77.75 ahead of 76.00-75.50 is valid. For now, let us watch consolidation at 78.75-80.25 with test/break either-way to attract. The strategy is to stay short at higher end with tight affordable stop for test/break of lower end into set objectives. In the meanwhile, EUR/JPY has reversed sharply from above 99 to take out 101. Here again, the short term trend is for test/break of 98.50 into 95.75. We need to look for right level to sell to set up a 500 pip trade. Watch this space in the twitter for the sell inititation.

Interest rate market

Bond market erased post-policy losses supported by OMO announcement to push the 10Y Bond yield to lower end of set near term ranges of 8.10-8.35% (new) and 8.35-8.60% (old) before close at 8.12% and 8.39% respectively. The LAF draw down is over Rs.1 Trillion and there will be more OMOs (probably every week or alternate week) to guide stability at the lower end of set ranges. The first signal of move into the higher end will be on cut in LAF draw down to below Rs.75K Crores. For now, watch 10Y (8.15% 2022) Bond yield at 8.10-8.20% and 8.79% 2021 at 8.35-8.50%. There will be buying interest in 8.79% 2021 on demand from RBI at its OMO counter; this would be a traders’ delight bond.

OIS rates stayed firm finding good support above the lower end of set ranges of 7.75-7.95% (1Y) and 7.25-7.45% (5Y) before close at 7.85% and 7.30% respectively. No change in view and the strategy is to stay paid at 7.80-7.75% (1Y) and 7.30-7.25% (5Y) for move into higher end in due course.

It was perfect move in FX premium, to ride the 3M from 6.25 to 7.25% and 12M from 4.75 to 5.75% and now closed at 7.2% and 5.7% respectively. What next? There is no sign of reversal despite this sharp move. The interest rate play is strongly in favour of up move while exchange rate play is neutral. The risk is of shift in exchange rate play on spot rupee reversal from 56.50-57.15 which could drive the premium sharply up. For now, let us watch 6.75-7.5% in 3M and 5.5-6.0% in 12M. The strategy is to stay “paid” for higher end. Let us pay 12M at 5.60-5.50% for 5.95-6.0%. It would be good for spot rupee if premium can stabilise at elevated levels.

Equity market

NIFTY got solid support from bullish cues from western bourses but weak domestic cues prevented an extended run, thus stalling the recovery from 5048 to 5141 before close at 5122. Our strategy was not to stay “long” at 5075-5175 with an intention to keep building shorts on signals of dilution in upside momentum which could extend up to 5175 with solid resistance at 5200 staying firm. There are no cues as yet to expect solid stimulus support from the FED or ECB; the resultant disappointment will drive the market down below 5000 to our near/short term objectives at 4775/4550. The extent of stimulus support in the western economies will make things difficult for quick revival; this is seen as temporary fillip and not permanent solutions for recovery. For now, let us watch 5000-5200 and await sharp reversal below the lower end for 4775/4550 in due course. We shall not stay “long” till reversal into 4775-4550 is seen. Strategic investors can continue to stay invested in Fixed Income as emergence of sustainable bullish trend is distant away.

Good luck....................................Moses Harding

MARKET PULSE: 19 JUNE 2012

MARKET PULSE: 19 June 2012

Currency market

The relief rally in rupee from 56.52 to 54.92 had a premature end without extension to 53.50. This expectation in rupee rally was subject to shift into pro-growth monetary stance which would then trigger accelerated off-shore flows into debt and equity market which in turn would drive the forward market into supply driven mode to guide extended rupee rally into 52, considered as fair value. RBI’s pause mode on CRR and policy rates has pushed rupee down from intra-day high of 55.26 to 56.03 before close of day at 55.91, thus opening up the risk of revisit to recent low at 56.52. The external stake holders (including Global rating agencies) consider issues relating to growth, fiscal deficit and governance as major factors for rating downgrade. Growth and fiscal deficit has direct relevance to shift into accommodative monetary policy. The delay in RBI’s growth supportive stance (and resultant pressure on GDP growth and fiscal deficit) has now pushed FITCH to join S&P to deliver downgrade by revising its rating outlook from stable to negative. There is also threat from them for moving India from investment grade to junk status. What next? The undertone is clearly bearish for rupee with immediate support at 56.18 ahead of 56.52. If this gives way, next targets will be at 56.90 and 57.13 which should hold. Taking these uncertainties (and risk factors), MARKET PULSE advised importers to cover 1-2M payables on spot gains into 55.00 and those who have done, there is no need to chase this near term weakness in rupee. At this stage, FIIs will get into wait-and-watch stance and may even trim their positions in debt and equity capital market. Let us consider external factors as neutral as USD Index stays in consolidation mode at 81.00-82.60. For now, let us watch USD/INR at 55.50-56.50 with bias into higher end. The bearish set up on rupee is gaining momentum and risk is for extended weakness into 56.90-57.15 before reversal. This zone is considered good for exporters to sell medium-long term receivables (12M dollars above 60) and good to convert rupee liabilities into USD for tenor 3-10 years. Strategic players can look to build dollar “longs” at 55.75-55.50 with tight stop for 56.90-57.15. Having said these, India sovereign rating downgrade to junk will be very negative for rupee into medium/long term; uncovered dollar liabilities and pipe-line ECB/FCCB payments will adversely impact corporate earnings and revenue collections for the Government. This scenario will be very bad for rupee and the Indian economy. Let us keep this risk factor at the back of our mind at this stage and await more cues for confirmation.

EUR/USD failed at higher end of set weekly range of 1.2400-1.2750 (high of 1.2747) and nicely reversed into the first support zone of 1.2600-1.2575 (low of 1.2560). What next? The relief rally post Greece elections had premature end at strong resistance at 1.2750 as it is not be-all and end-all in the Euro zone crisis. The bearish set up from the Euro zone continues to stay valid and QE3 from the US zone is distant away, and dollar would continue to stay safe-haven till then. For now, let us watch consolidation in EUR/USD at 1.2425-1.2675 with test/break either-way not expected to sustain. There is an outside chance of extended weakness into 1.22-1.18. The strategy is to play end-to-end of this range with stop/reverse strategy for sub 1.22 or over 1.29. Keep a watch on twitter account for intraday trade ideas.

USD/JPY held at higher end of set weekly range of 77.50-79.25 (high of 79.29) and held well at immediate support at 78.85. There is no change in view of looking for extended weakness into 78.10/77.60. The expectation of further weakness into 76.00-75.50 is valid to complete end-to-end of set near term range of 75-80 (high already posted at 79.74). Any relief rally in USD/JPY will be difficult to sustain beyond 80.25 at this stage. For now, let us watch 77.50-79.75. The strategy is to stay short for 78.10-77.60; if stopped sell again at 80.25 with stop above 80.50. In the meanwhile, EUR/JPY had an extended rally over 100.30 but failed at the next hurdle at 100.90 (high of 100.85) and posted a sharp fall to 99.20 from there. There is no change in view for test/break of 98.50 for extended run into 95.65 in the near term. For now, let us watch 98.50-100.30 with immediate bias for test/break of lower end for extended run into 97.25 ahead of 95.75.

Interest rate market

10Y bond (8.79% 2021) has unwound most of its recent rally from over 8.50% to below 8.30% before close at 8.43%. The new 10Y bond (8.15% 2022) rallied sharply from 8.15% to 7.95% and now at 8.17%. The recent rally was built based on expectation of policy action of 25-50 bps rate cut. MARKET PULSE considered not prudent to chase gains below 8% (new 10Y Bond) and 8.30% (old 10Y Bond) as this would need 50 bps rate cut from RBI and given the uncertainties in the external sector, 10Y yield below 8% is bit stretched. It would have been an 8.0-8.15% range in anticipation of rate moves in Q2/Q3 of FY13 but for the late evening FITCH downgrade which added to the disappointment. Most (if not all) emerging and developing markets are in monetary easing mode to counter headwinds from external sector. But they do not have inflationary and CAD pressures in their system. The fear of rating downgrade and quantitative easing in western economies (and resultant rally in commodity prices) will keep the market in bearish mode into July monetary policy review. The comfort is from OMOs from RBI. The take-away is that RBI may not get into rate reversal cycle till sharp reversal in headline WPI/CPI is sighted. It is now considered that inflation adjusted lending rates are low, hence not considered as anti-growth. The surprise is the sudden change of stance after delivering 50 bps rate cut on 17^th April, which has built expectation of further easing considering this as shift into growth supportive monetary stance. The Indian economy will now stay tuned to sub 6% GDP growth till headline inflation ease below 6%. For now, let us watch new 10Y Bond yield at 8.10-8.35% and old 10Y 8.79% 2021 bond yield at 8.35-8.60%. The strategy is to stay aside and allow extended weakness into higher end before build up of short term investment book.

OIS rates are sharply up post-policy; 1Y rate rallied to 7.82 (from recent low of 7.44) and 5Y rate into 7.31 (from recent low of 7.13) and looks set for extension into 7.88-7.93 (1Y) and 7.38-7.43 (5Y) in the near term. The shift of priority to headline inflation (WPI and CPI) could delay the process of shift into growth supportive monetary stance. The risk is of OIS rates staying at elevated level till downtrend in inflation is sighted. For now, let us watch 1Y at 7.75-7.95% and 5Y at 7.25-7.45% with immediate bias into higher end. The strategy is to stay paid for this move and look to switch sides there if bullish cues emerge by then.

FX premium has completed its end-to-end move within the set near term range of 6.25-6.75% (3M) and 4.75-5.25% (12M) for close at 6.70% and 5.25% respectively. What next? The interest rate play will exert strong upward pressure but there would be strong headwinds from exchange rate play tracking rupee weakness into 56.50-57.15. However, the momentum will be up for 7% (3M) and 5.65-5.75% (12M). For now, let us watch 3M at 6.5-7.0% and 12M at 5.15-5.65% with immediate bias into higher end. The strategy is to stay paid for this move. Let us pay 12M at 5.15-5.0% with tight stop for 5.65-5.75%.

Equity market

MARKET PULSE highlighted the risk of sharp reversal into 5000-4975 on disappointment from RBI with resistance at 5200 staying firm. It was to the script as NIFTY fell from pre policy high of 5189 into low of 5042 before close at 5064. FITCH downgrade was delivered after market close to give a respectable close above 5050. What next? Now, NIFTY moves will get disconnected from western bourses as domestic cues will dominate. The domestic scenario is dominated by higher bond yields and weak rupee. The fear of sub 6% GDP growth for FY13 is not good for equity asset. There is clear risk of market getting into aggressive sell mode both from domestic and FII investors while bulls are expected to run for cover. The focus now shifts to recent low of 4770 seen on 4^th June before posting a sharp rally into 5189 on rate cut expectation. Further ahead is the low of 4531 seen on 23^rd December 2011 before posting over 1000 points rally into 5630 on FII driven rally. It is unfortunate that now we are looking at revisit of these levels. There is not a single factor to stay “long” and let us stay aside and allow weakness into these levels for build up of investment book into the short term. For now, let us watch 4775-5075 with immediate bias into lower end. The strategy is to stay “short” for this move. Let us watch price action around 4775 to set up the next target; short term range is now shifted to 4500-5000. Strategic investors can stay invested in Fixed Income assets to avoid losing capital and earn for time value.

Good luck..................Moses Harding   

bolt from the blue from the RBI

Preference for headline inflation over growth and less optimism over Government’s initiatives

It was not unfair on the part of market stake holders to expect minimum 50 bps cut in CRR and 25 bps rate cut. SBI Chairman, the biggest stake holder had highlighted the economic need for 100 bps CRR cut and 50 bps rate cut. The reasons for such expectations were many: core inflation down below 5%; definitive downtrend in fuel price inflation on 25% fall in BRENT Crude price; Government’s assurance to address food price inflation through supply side measures; sharp downtrend in GDP growth into 5% and so on. Moreover, RBI had already delivered a “pleasant surprise” on 17^th April through 50 bps rate cut against market consensus. There are no significant developments since 17^th April to deliver “unpleasant surprise” through reversal of stance against market consensus. Now, stake holders will analyse reasons for this behaviour. It may be that RBI is now concerned on elevated headline inflation and await Government’s measures (and actions) to ease pressure on food and fuel price inflation before taking a firm growth supportive monetary stance. Will it be due to change of guard at the ministry to get more clarity on its actions on fiscal consolidation and food price inflation? The only consolation was increase in export finance limit from 15% to 50% which can be seen as MSF at Repo rate, but this support is not very relevant when its usage is not significant by most Banks. The post-policy impact on the markets was not a “surprise” for sure. Short term money market rates are up; Bond yields up, rupee down and equity market down. Over all, bullish expectation into the midterm policy review and the resultant rally across asset markets is now fully undone!

What next? 3-12M money market rates is now back at 9.25-9.75%; 10Y Bond yield at 8.35-8.50% (8.79% 2021) and 8.10-8.25% (8.15% 2022). Rupee is back to its bearish trend having taken out strong support at 55.65 and NIFTY into consolidation mode above 5000. RBI action will be disappointment for off-shore investors (who were invested in debt/equity assets to “ride” the shift to pro-growth stance) who may now either get into wait-and-watch stance or exit the scene where feeling the pulse is difficult. Let us now stay tuned to domestic economic data and signals from external sector. It is not the time to stay invested and we stand aside for more cues into the future. Till then, watch consolidation in 10Y (8.15% 2022) Bond yield at 8.10-8.25%; 5Y OIS at 7.20-7.45%; NIFTY at 4700-5200 and USD/INR at 55.30-56.50 not ruling out extended weakness across all asset markets. The strategy is to stay invested on extended weakness outside the set ranges for run into July quarter policy review.

Good luck.....................Moses Harding

An analysis on macros into midterm review of monetary policy

Structural dynamics

·       There is lack of confidence (from both domestic and external stake holders) on the political system to roll-out reforms (relating to attracting off-shore investments; tax reforms; land reforms; labour reforms etc) and address fiscal consolidation. There is no political consensus to move forward and Congress Party is struggling to get support from within and outside UPA on case-to-case basis

·       The economic scenario is at risk of stagflation; GDP growth below 6% and inflation above 6%. The domestic contribution to GDP is steady but no clear signs of support from external sector

·       The monetary scenario is not growth supportive; deficit liquidity with Rs.1 Trillion draw-down from LAF and overnight MIBOR at higher end of LAF corridor, the Repo rate. RBI’s hawkish stance on monetary policy has guided downtrend in headline (and core) inflation but has hurt growth.

·       Current Account deficit (CAD) and Balance of Payment (BOP) is under severe strain. The need is to address imports and ensure steady flows into capital account while the system awaits improvement in western economies to build exports. Government and RBI (and Government) should look at cutting non-essential imports and increase domestic production on essential imports to have permanent solution to CAD and stay less dependent on external flows. CAD is higher at 4% of GDP and negative BOP has already exerted pressure on the exchange rate with rupee sharply down by 30% since July 2012 (from 44 to 56)

Growth-inflation dynamics

·       FY12 GDP growth has slipped from 8% in Q1FY12 to 5.3% in Q4FY12; sharp slippage against end FY12 estimate of 7.6%. There is across-the-board pessimism on expectation for FY13; most stake holders estimate GDP growth for FY13 at below 6% as against Governments estimate of 7.1% for FY13. There is no improvement in the external sector and the need is to ramp up domestic contribution to GDP. There is immediate need for RBI and Government to focus on growth through (a) attracting off-shore liquidity and capital; (b) attract domestic investments; (c) increase domestic consumer demand; (d) enhance domestic capacity; (e) increase public investments on core sectors and (f) higher focus on agriculture, infrastructure and natural resources

·       FY12 headline WPI inflation has slipped from near 10% in Q1FY12 to 7.5% in Q4FY12. There is comfort from sharp slippage in core inflation (at 4.8% for May 2013) while food and fuel prices stay at elevated levels. RBI has no role to play in managing food price inflation but there is comfort from the Government that it would moderate this number through various supply-side measures. There is optimism in fuel price inflation tracking sharp reversal in crude oil price with BRENT Crude down from $128 a barrel to below $100 a barrel. But, this benefit is completely knocked out by sharp depreciation in rupee from 44 to 56 (30% depreciation is BRENT Crude is undone by 30% depreciation in rupee; thus the landed cost of crude in rupee value is steady at elevated levels)

·       FY12 fiscal deficit at 6% of GDP is a serious concern. The market borrowing by the Government is huge. The fiscal deficit is used for consumption and not for capacity creation; thus adding burden on the future with high interest cost. Government has budgeted to limit cost subsidisation to 2% of GDP

·       RBI was considering inflation as major risk to growth and the monetary system is still in hawkish mode despite delivery of 125 bps CRR cut and 50 bps rate cut. The need is to drive system liquidity into surplus mode and shift overnight rates into lower end of LAF corridor, the Reverse Repo rate to shift the monetary system to growth supportive mode.

Trend on major indicators

·       There is severe downside risk to growth. There will not be support from external sector in FY13. Euro zone is vulnerable and US economy is showing signs of weakness with expectation of QE3 support before Q4 of CY2012. There is optimism on domestic output subject to support from the Government and RBI’s shift into growth supportive monetary stance.

·       Fuel price inflation is comfortable and sharp fall in BRENT Crude since May 2012 will get favourable reflection in pipe-line data. It is also believed that the worst is behind for rupee with low risk of rupee posting a new all-time low above 56.52. The trend for fuel price inflation is down tracking further fall in BRENT Crude price and gradual rupee appreciation to 53 during FY13

·       Food price inflation is high driven by good demand not met with adequate supplies. A good monsoon and measures from the Government to address supply side concerns will help to guide moderation in food price inflation during the course of FY13

·       The sharp fall in commodity prices will release the pressure on CAD; import bill of crude in USD terms is already down by 25% (annual benefit of USD 60-75 billion). The growth supportive monetary stance would attract off-shore investments into debt and equity market. Over all, trend in CAD and BOP is positive; considered good for exchange and interest rate

·       The trend on fiscal deficit is positive. The fuel subsidy bill will be down tracking downtrend in BRENT Crude and USD/INR. The deficit situation will improve significantly even without pass-through to consumers. If the Government choose to pass-through, its impact on inflation will be manageable

Expectations from RBI

·       It is obvious (from the above) that downside risks to growth are severe than upside risks to inflation

·       The economic and market forces which were exerting pressure on exchange rate and interest rate has shown signs of moderation and expected to shift into favourable mode during course of FY13

·       There is no risk of sovereign rating downgrade given the high confidence to manage fiscal deficit; CAD and BOP (RBI may not consider this as conflict of interest for shift into easing monetary policy)

·       The monetary supportive stance since January 2012 has not turned growth supportive (despite 125 bps CRR cut and 50 bps rate cut) as monetary dynamics are still anti-growth (deficit system liquidity and overnight rates at Repo rate)

It is a straight-forward case for RBI to inject liquidity and cut rates. The issue is on the quantum. The system liquidity is short by 150 bps of NDTL; hence there is need to cut CRR by say 50-75 bps (it will be wishful to expect one-shot cut of 100-150 bps; liquidity injection has to be in combination of CRR cut and OMO to provide stability in bond yields to keep borrowing cost of the government at low/affordable rate). This (CRR cut of 50-75 bps) may not be good enough to guide overnight rate from Repo rate to Reverse Repo rate; thus overnight rate will continue to stay above 8%. So, the action has to be in combination of CRR cut and rate cut, say by 25-50 bps. So, there are four combinations:

1.     75 bps CRR cut and 50 bps rate cut (0% probability)

2.     75 bps CRR cut and 25 bps rate cut (25% probability)

3.     50 bps CRR cut and 50 bps rate cut (50% probability)

4.     50 bps CRR cut and 25 bps rate cut (25% probability)

Moses Harding