MARKET PULSE: Weekly report for 18-22 June 2012
It is rather straight-forward for RBI to cut policy rates and inject liquidity
The revised (and actual) economic data for FY12 is on hand now. During the course of FY12, GDP growth was down from 8% to 5.3% (from Q1 to Q4); sharply down on quarterly sequential basis. During the same time, headline inflation was down from 10% to 7.5%; down on quarterly sequential basis. The core inflation was down at 5% while food and fuel inflation were high driven by high crude oil prices and supply-side issues. The impact from the growth-inflation dynamics resulted in sharp overshoot in fiscal deficit and swift shift into tight monetary conditions. The reason for pressure on growth in FY12 is attributed to weak external sector; tight liquidity and high interest rates. The major cause for high fuel inflation was due to sharp rise in BRENT crude from $98 to $128 a barrel and rupee weakness from 44 to 56; resultant 60% impact on landed rupee cost of crude oil was not passed through to the consumers, thus releasing pressure on inflation but exerting pressure on fiscal deficit. The pressure on food inflation is attributed to higher demand not being met with adequate supplies. The factors concerning RBI in these issues are liquidity and cost of liquidity. The task on hand for RBI (and the Government) is to reverse the trend for FY13. The GDP growth has to be pushed from 5.3% to minimum 7% and headline inflation from 7.5% to minimum 6% on quarterly sequential basis. What is the trend on inflation? There will be sharp downtrend in fuel inflation; BRENT crude is already down from $128 to $97 and looks good extended reversal into $85 during course of FY13. It is also possible that the worst for rupee is already behind and rupee will get into consolidation mode at 53.5-56.5. So, taking these two factors together, there is good chance of sharp reversal in fuel price inflation and the Government has enough room to reduce cost subsidisation without hurting inflation. On the other hand, food price inflation is set to peak; the demand is already is at its peak while good monsoon and bit of effort from the Government to address supply side concerns will moderate food price inflation. While RBI has limited role to play to contain food price inflation, it is important for the Government to provide comfort to RBI in this regard. The outlook on core inflation is neutral to soft. The higher demand from uptrend in GDP growth will be met with capacity expansion on shift into growth supportive monetary stance; domestic investments will pick up significantly tracking low interest rates and easy liquidity to build capacity and supplies. The money market conditions have also turned positive for the Government to complete its FY13 borrowing programme at affordable cost; aggressive measures on fiscal consolidation will send positive vibes into the future. It is clear that downside risks to growth is much severe than upside risks to inflation in FY13. Taking all these together, it is rather straight-forward for RBI to shift system liquidity from deficit to surplus and effect rate reversal cycle. The process has already begun; RBI has delivered 125 bps CRR cut and 50 bps rate cut. But despite these actions, system liquidity is short by Rs.1 Trillion and short term rates are at elevated levels with 3-12M rates at 9.25-9.5%. It is important that RBI continue with these measures till monetary system turn supportive to growth. What will RBI do on 18th June? There is demand from stake holders to release cash into the system. Some large players demand as high as 100 bps CRR cut. It is also obvious that CRR cut (by less than 150 bps) without rate cut is irrelevant at this stage as operative policy rate will continue to stay at higher end of LAF corridor, the Repo rate at 8%. The minimum expectation from RBI is for delivery of 50 bps CRR cut and 25 bps rate cut to avoid bearish set up across equity, fixed income and currency markets. In this case, it is important to keep option open for more rate cuts into the future. There is another important political development that has hit the system. Congress Party has come out successful in handling the political crisis from the Presidential election; FM’s elevation to the President of India is certain now. This gives comfort to stake holders that UPA Government will make the best use of rest of its term (till 2014) to address issues relating to reforms and fiscal consolidation. These expectations build a strong case for delivery of 50 bps cut in CRR and 50 bps cut in policy rates to get the best of impact on asset markets. MARKET PULSE sets 51% probability on 50 bps cut in CRR and policy rates and 49% probability on 50 bps CRR cut and 25 bps rate cut (with guidance on more rate cuts into the future).
Interest rate market
It was a volatile week in Bond/OIS market. 10Y (8.79% 2021) Bond traded end-to-end of set weekly range of 8.25-8.35% before close of week at 8.33%. The new 10Y (8.15% 2022) was more volatile for sharp gains into 7.96% before close of week at 8.03% where we asked not to chase gains beyond 8%. 1Y OIS rate was more volatile but stayed within the set weekly range of 7.40-7.65% with low of 7.44; high of 7.62% before close of week at 7.57%. 5Y OIS rate was relatively steady trading end-to-end of 7.10-7.25% before close of week at 7.17%. What next? 10Y Bond has priced-in 50 bps CRR cut and 25 bps rate cut. It would need 50 bps rate cut to allow extended rally beyond 8.25% (8.79% 2021) and 8.0% (8.15% 2022). Given the positive expectations into the future, the trend into FY13 is positive but it is also fact that bullishness in bond market was also driven by RBI’s OMO bond purchases. Therefore, it is important for RBI to continue its use of OMO bond purchases till most of market borrowing for rest o FY13 is out of the way. It is also possible that RBI may not like extended rally in 10Y bond yield below 8% at this stage and may discontinue OMO to provide post-policy price stability in new 10Y Bond yield at 7.95-8.10% and 8.20-8.35% (8.79% 2021). For the week, let us watch 10Y (8.15% 2022) bond yield at 7.95-8.05% with test/break either-way to attract. Strategic players can continue to stay invested for short term move into 7.65-7.5% while traders look to play end-to-end of this range. The risk of new 10Y bond trading at discount (yield above 8.15%) is limited at this stage; hence would consider 8.05-8.15% as good for keeps into short term.
1Y OIS rate will find strong support at 7.40-7.45% zone till system liquidity shifts into surplus mode while 5Y OIS rate stay in consolidation mode tracking sideways trading mode in the Bond market. However, short term trend is for move lower ahead of signs of shift in operating policy rate from Repo rate to Reverse Repo rate; need to have close watch on system liquidity. For the week, let us watch 1Y at 7.35-7.60% and 5Y at 7.05-7.20% with bias into lower end. Strategic investors can hold on to “received book” for short term target at 7.10-7.0% (1Y) and 6.90-6.80% (5Y).
12M FX premium nicely traded end-to-end of set weekly range of 4.75-5.25%; sharply up from lower end to higher end before close of week at 5.2%. In the meanwhile 3M was in tight consolidation mode at 6.25-6.5%. What next? The interest rate play sets up bearish momentum while exchange rate play is neutral. There should be significant dilution in upward momentum from now on. For the week, let us watch 3M at 6.0-6.5% and 12M at 4.75-5.25%. The strategy now is to stay “received” in 12M at 5.25-5.35% for 4.85-4.75%.
Currency market
USD/INR played perfect to the script; rupee posted weekly low of 56.07 before close of week strong at 55.39. MARKET PULSE continued to highlight the risk of staying “long dollars” above 56 and considered good to cover 3M/September 2012 exports at forward value above 57 while asking importers to stay away for spot move into 55.00 to cover spot next-1M payables. There was release of bearish pressure on rupee driven by bullish signals in equity market and USD Index losing steam above strong resistance at 82.60; fell from high of 82.73 to 81.48 before close of week at 81.59. What next? The serious concerns on political and economic woes stand diluted. The smart handling of UPA’s presidential nominee brings in confidence on the ability of UPA to bring consensus to roll-out critical reforms and fiscal consolidation. It is crisis time and there is hope of managing the crisis well by the UPA. Also, RBI’s shift into aggressive growth supportive stance will address economic woes. However, market forces are neutral and mixed. There is no clarity on movement in USD Index; there is strong support at 81.05-80.90 which will limit rupee gains beyond 54.90. Rupee unwinding its entire weakness from 55.01 to 56.52 will add confidence to rupee bulls. For the week, let us watch 55.00-55.60 with extension limited to 54.65-55.95. It is good for importers to cover near term imports on extended gains into 55.00-54.65 and to unwind “short dollar” positions and stay square for fresh cues. The risk of reversal from here into 55.60-55.95 is not ruled out for near term consolidation at 54.65-55.95 tracking reversal in USD Index from 81 to 83.50.
EUR/USD moved up sharply from support at 1.2450-1.2425 (low of 1.2441) into the set resistance/sell zone at 1.2670-1.2730 (high of 1.2664) before close of week at 1.2636. The trade ideas suggested in twitter was good for 150 points (stay tuned to twitter account for intraday trade ideas on currencies). What next? The developments in the Euro zone and expectations of QE3 from the FED provide solid two-way volatility in EUR/USD. Now, it is important for EUR/USD to lose steam at solid resistance zone of 1.2725-1.2750 (USD Index around 81) to keep the expected move into 1.2250-1.2200 in play; else the relief rally in EUR/USD will extend further into 1.29-1.30. It will be a volatile week and we track 1.2425-1.2725 and stay neutral on break-out direction which could then extend to 1.2225 or 1.2925. The strategy is to sell at 1.2700-1.2750 and buy at 1.2450-1.2400 with stop/reverse for 1.2925 or 1.2225 respectively.
USD/JPY met the set objective at 78.50 (low of 78.59) while staying below 80 (high of 79.74). In the meanwhile EUR/JPY held well above set strong support at 98.50 (98.68) and reversal from there failed at 100.30 (high of 100.35) for close of week at 99.50. What next? USD/JPY looks good to test the set near term target at 77.75 and for further extension into 76.00-75.50 before reversal. This move along with reversal in EUR/USD from 1.2725 could guide EUR/JPY below 98.50 into recent low of 95.64. For the week, let us watch USD/JPY at 77.50-79.25 and EUR/JPY at 97.25-100.25 and the bias is into lower end. The strategy is to stay “short” for this move.
Equity market
NIFTY was well supported by rate cut expectation and shift into growth supportive monetary stance to hold well above 5000 (low of 5015) but did not generate enough momentum to take out strong resistance at 5150-5200 (high of 5146) but weekly close at 5139 is bullish into the near term. In the meanwhile DJIA sailed through strong resistance at 12700 (high of 12774) for strong weekly close at 12767. Over all, domestic and external cues turned supportive for the NIFTY but despite these strong forces, inability to take out 5200 is a worry. What next? DJIA is set to recover in full the sharp fall from 13338 to 12035 (since 1st May to 4th June) with immediate resistance at 12840 and 13060 while 12685-12530 holds firm. This move in DJIA has perfect reflection in NIFTY since the rally from 4770 (since 4th June) to 5150 (8% rally in NIFTY as against 10% in DJIA). The domestic cues from RBI and political gains of Congress over the Presidential election should add momentum to NIFTY with targets at 5300/5450 on conclusive break of 5200. This would also open up 100% retracement of 5630 to 4770 (since 26th February to 4th June) while 5100/4975 stays firm. For the week, let us watch 5100-5300 not ruling out extended rally into 5450. The risk factor to this move is on disappointment from RBI to drive NIFTY into 5000-4975 which should hold.
Commodity market
Gold has now traded end-to-end of 1560-1640 range (from 1561 to 1633) before close of week at 1627. This also completes the 100 dollar trade set up that we had from 1535 to 1640. What next? Gold is looking bullish to take out strong resistance at 1640-1645 for extended rally into 1700 and beyond to get the focus into recent high of 1790. For the week, let us watch 1590-1660 not ruling out extended rally into 1690 and prepare for further extension into 1730. The strategy is to stay “long” for this move with stop at 1585.
NYMEX/WTI crude is held well above strong support at 80-81 (low of 81.07) and into consolidation mode at 81-85 before close of week at 84.03. It is in order to allow this consolidation after sharp reversal from over 110 since early March 2012 by over 25%. What next? Now, any correction rally should fail at 85-87 for test/break of 81.25-81.00 into 75 to complete end-to-end move of the set short term range of 75-110. Beyond there, slow recovery in global economy and increased supplies can get the focus into 65 which is great news for Indian economy. For the week, let us watch 80-87 with test/break either-way not expected to sustain. The strategy is to trade end-to-end of this move with tight stop on break thereof.
Have a great week ahead..........................................Moses Harding
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