MARKET PULSE: Weekly report for 12-15 June 2012
Run up to RBI’s mid quarter review of monetary policy on 18th June 2012
The sluggish growth momentum and moderation in headline inflation has pushed RBI for move into aggressive growth supportive monetary stance ahead of expectations. The FY13 Budgetary estimates on GDP Growth above 7% looks very ambitious in the absence of favourable monetary conditions with immediate need to drive system liquidity into surplus mode and at low (and affordable) cost of funds. The concerns over fiscal deficit and core inflation have lost its priority as low growth will cause severe damage to fiscal consolidation. There has been significant release of pressure on Current Account deficit triggered by sharp fall in crude oil price and reduction in bullion imports. The rate cut expectation and resultant relief to Equity and Fixed Income asset classes will bring back FII investors into the market to remove worry on deficit Balance of Payment. Now, S&P has come out with threat to downgrade sovereign rating below investment grade if issues related to growth are not immediately resolved. It is also an alarm bell to political leaders if they do not stand together on reforms and fiscal consolidation. It is a crisis time and it is time to act fast and hard. MARKET PULSE highlighted the risk of India’s exit from the investment grade BRICS group given the complexities across political, economic and monetary systems which has put the macro fundamentals of the Indian economy at risk.
The system liquidity will be short by over Rs.1 Trillion post advance tax outflow. There is strong case to cut CRR by minimum 50 bps. This will also release pressure on RBI on the need to continue with its OMO bond purchases when longer tenor Bond yields are already down. However, stand alone CRR cut may not guide rates down significantly till operative policy rate is maintained at higher end of LAF corridor, the Repo rate. There is also immediate need to pull domestic investments (and consumption) by moving the operative policy rate to the lower end of LAF Corridor, the Reverse Repo rate through infusion of sufficient cash into the system; most of Q1 of FY13 is already behind and any further delay will hurt FY13 Budgetary aspirations. This brings the need for delivery of rate cut of 50 bps to push overnight MIBOR from above 8% into 7.5%. There is tremendous pressure to bring in optimism into the stake holders who have revised the GDP growth estimation to around (or below) 6%. The change in sentiment will happen if RBI could set the road map for CRR at 3.5% and operative policy rate at 6.5% during the course of H1 of FY13. RBI has already taken three big steps through delivery of 75 bps CRR cut; 50 bps CRR cut and 50 bps rate cut since mid March 2012. It is essential (and critical) to continue with these actions when the need is high. The best (and prudent) option at this stage will be delivery of 50 bps cut each in CRR, Repo rate and Reverse Repo rate. There will be disappointment on delivery of 25 bps rate cut along with 50 bps CRR cut; considered as baby step. It would also be good if RBI could review and bring down the MSF rate to Repo rate till RBI is in a position to cut SLR. The 2% SLR refinance facility at MSF counter at rate 1% above Repo rate deprive the facility of investors to get these excess SLR investments refinanced from CBLO market at rates within the LAF corridor. Moreover, this facility is not being used by Banks and it will be good if RBI drive this 2% SLR liquidity (into the system) at Repo rate. This is essential to drive deposit rates down to effect pass-through to lending rates. Over all, RBI has two options on hand: (a) 50 bps cut each in CRR and policy rates (51% probability) and (b) 50 bps cut in CRR and 25 bps cut in policy rates (49% probability). Any other options in the form of 25 bps rate cut without CRR cut or 50 bps CRR cut without rate cut will be very negative on the market while 50 bps rate cut without CRR cut will be neutral. MARKET PULSE would expect giant strides from RBI when the operating environment is tough and business (and investor) confidence is weak; to revive optimism in the minds of investors, consumers and business enterprise. It would be fair to expect delivery of 50 bps cut each in CRR, Repo rate and Reverse Repo rate. If the undertone (and road map) is set for move into 6.5% operative policy rate and 3.5% CRR before end of September 2012 (ahead of shift into busy season), the short term targets will be at 7.0% (1Y OIS); 7.5% (364D T-Bill); 8.0% (10Y G-Sec) and 7.0% (5Y OIS).
Currency market
Rupee weakness lost steam ahead of the upper end of set weekly range of 54.65-55.95 (low of 55.91) for a one rupee correction into 54.92; but fell sharply to 55.82 post S&P threat of downgrade before close at 55.75. Rupee losing the one rupee advantage in quick time is not good at all into the near term. It is unfortunate for RBI that S&P threat has come at the wrong time to make things difficult to arrest rupee weakness from now on. There has been significant improvement in CAD and BOP. The sharp fall in BRENT Crude from over $128 a barrel to below $100 since March 2012 is big relief to cut import bill in dollar terms. It is a different story that this benefit is not extended to inflation or fiscal deficit due to sharp fall in rupee during the same period. There is appreciable fall in bullion, capital goods and non-essential imports. The signal of rate reversal and shift into surplus system liquidity conditions will divert off-shore liquidity into Indian Debt and Equity capital markets to keep BOP positive which in turn will drive forward market into supply driven mode. Over all, it is possible that rupee has seen a short term low at 56.52 and looks set for unwinding of its weakness from 48.60 to 56.52 with immediate target at 54.65. If all goes well, rupee should further extend its gains into 53.50 to complete end-to-end of revised short term range of 53.50-56.50. What is the risk factor to this move? The rally in USD Index from 78.60 met with strong resistance at 83.50 (high of 83.54); reversal from there has been sharp for move below 82.00 but the risk is of retest of 83.50 while 81.80 stay firm. This could open up rupee weakness into 55.95-56.50 but not expected to post a new all-time low given the improved conditions in CAD and good FII appetite into debt and equity capital market. It is possible that S&P will take note of RBI’s growth supportive monetary stance and delay rating action on India. For the week, let us watch 54.90-56.25 with extension limited to 54.65-56.50; initial bias will be into higher end but expected to attract good supplies for gradual reversal into lower end in due course. The strategy is to sell 3M/September 2012 exports at 57.25-57.50 while importers stay away for spot reversal into 54.90-54.65 to cover up to 1M imports around 55.00. Strategic traders can look to sell at 56.25-56.50 with affordable stop for short term target at 53.50. Fleet footed traders can play end-to-end of this range with tight stop on break there-of; it would be a very low risk-high reward trading opportunity, similar to the recent one rupee move (both ways) from 55.91 to 54.92 to 55.82. There is no reason at this stage to review the set short term range of 53.50-56.50; we will watch price action at 55.95-56.50 to get more clarity on directional break-out.
The rally in EUR/USD from above the first pit stop at 1.2250-1.2200 (low of 1.2286) had very good momentum to generate nearly 400 pip rally to high of 1.2668 where “relief rally” fizzled out for move below 1.25. The financial bail-out in Spain and relatively highly overvalued US Dollar created “short squeeze” to provide bit of relief to Euro which is looking weak and vulnerable. What next? The rally in EUR/USD looks good but not seen as bullish reversal at this stage. There will be good selling appetite at various levels which would limit gains at 1.2750. Over all, trend for EUR/USD is bearish and it is matter of time before 1.25 gives way for one more look at 1.2286 before heading into 1.22-1.18. For the week, let us watch consolidation at 1.2250-1.2750 and test/break either-way will attract. The strategy is to sell at 1.2700-1.2750 (with stop above 1.2775) for 1.2300-1.2250.
The rally in USD/JPY from 77.65 lost steam ahead of psychological resistance at 80 (high of 79.78) while EUR/JPY posted a 5 big figure rally from 95.57 to 100.88 driven by relief rally post EUR 100 Bio bail-out package to Spain. What next? Euro should enjoy the Spain package advantage till another set of weak news from Portugal or Greece hit the market. US economic woes and resultant QE3 expectations before Q4 of 2012 also provides support to non-dollar currencies. While the trend is down, we may need to allow for recovery in the immediate term. USD/JPY can extend its gains above 80 into 81.00 while support around 79 holds firm. Similarly, EUR/JPY can extend its relief rally into 102.00 (higher end of recent near term range of 97-102). We need to watch price actions in USD/JPY above 81 and in EUR/JPY around 102 to fix the next big move. For the week, let us watch USD/JPY at 78.50-80.50 and EUR/JPY at 98.50-102.50 and stay neutral on break-out direction. The strategy is to play end-to-end of these ranges with tight affordable stop on break thereof.
Interest rate market
Bond market is bullish driven by rate cut expectations; 10Y Bond yield was in consolidation mode at 8.30-8.35%. In the meanwhile new 10Y benchmark bond was subscribed at a very aggressive coupon of 8.15%. OIS rates are steady around 7.60% in 1Y and 7.25% in 5Y. What next? Bond market has priced-in 25 bps rate cut and 50 bps CRR cut. The expectation is for more aggressive actions in injecting liquidity to drive the call money rate into the Reverse Repo rate. The monetary system cannot support growth by operating at the higher end of LAF corridor with huge daily draw down from LAF counter. For the week, let us watch 1Y OIS at 7.40-7.65%; 5Y OIS at 7.10-7.30 and 10Y Bond (8.79% 2021) yield at 8.25-8.35% and new 10Y Bond (8.15% 2022) yield at 8.05-8.15%. Over all, it is good to stay invested in bonds (and received in OIS) into the monetary policy when RBI is not expected to send unpleasant surprises into the market. Having said these, there is no clarity at this stage to chase gains beyond the set lower ends and would be prudent to exit and stay square and allow decent correction to re-build investment book.
12M FX premium played end-to-end of set 4.75-5.25% before close around 5%; the bounce from 4.75% was sharp while being heavy at 5.15-5.25%. In the meanwhile interest rate play kept the shorter end bit soft with 3M premium trading around 6.5%. For the week, let us watch 3M at 6.25-6.75% and 12M at 4.75-5.25% with test/break either-way not expected to sustain. The trading strategy is to pay 12M at 4.85-4.75% and receive at 5.15-5.25% with tight affordable stop. The short term trend continues to stay bullish while the near term outlook is mixed driven by contradictory forces between interest rate and exchange rate play.
Equity market
The strong rally in NIFTY from the first buy level of 4775 (low of 4770) extended beyond 5000 (into high of 5124) only to erase gains post S&P threat for close at 5054. All factors in favour of NIFTY struck at the same time; rate cut expectations from RBI, financial support to Spain and QE3 expectations in the US. NIFTY also tracked sharp reversal in DJIA from 12035 to 12650. There are lot of positive take-away into the near term. The sharp reversal in DJIA back above strong support at 12200 is positive with focus back into the earlier resistance at 12550-12700; break of which will be good. On the domestic front, RBI is expected to turn growth supportive not ruling out more monetary actions into the future. The concerns are from the Euro zone; the rupee and S&P. There are no clear cues to take short/medium term view at this stage and would stay neutral to mildly bullish on the near term outlook and look for good levels to “short” the NIFTY. MARKET PULSE highlighted the risk of India being pushed out of BRICS group and S&P has highlighted the same risk factor of India losing its investment grade status and losing the advantage it gained being part of the BRICS group. Let us now set aside S&P factor and have close watch on the rupee and the Euro zone. For the week, let us watch two-way sideways trading mode within 4700-5200 with initial bias into lower end. The strategy is to play end-to-end of this range as test/break either-way will attract.
Commodity market
Gold traded to the script; rallied sharply from 1527 (above the set buy zone of 1525-1485) to hit the set objective at 1640 (high of 1640.50); reversal from there held above the buy zone of 1560-1535 (low of 1561.44) before getting into consolidation mode at 1580-1610. What next? Gold continues to retain its bullish undertone and looks good for test/break of 1640 into 1680-1715 while 1560-1535 stay firm. For the week, let us watch 1560-1640 with bias for extended gains into 1680. The strategy is to stay “long” for this move with tight stop on break of lower end.
It was perfect move in NYMEX Crude; first chased the reversal from above 110 to below 83 and got opportunity to reinstate “shorts” at 85.5-87.5 as correction from 81.21 failed at 87.03 and now in consolidation mode around 83. What next? The undertone continues to be bearish and there are no factors to look for bullish reversal. For the week, let us continue to watch 75-88 with bias into lower end. The strategy is to stay “short” for this move with tight stop on break of higher end.
Have a great week ahead.............................Moses Harding
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