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.

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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