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 17th 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 4th June before posting a sharp rally into 5189 on rate cut expectation. Further ahead is the low of 4531 seen on 23rd 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
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