RBI's stance on 3rd May?

Tough for RBI to shift priority from inflation to growth

It is one of rare occasions when market stake holders are unanimous in demanding 25 bps rate cut from RBI. There are strong reasons for it; (a) headline WPI inflation is below 6% (b) core inflation is steady below 4% (c) inflationary build-up from twin-deficits are diluted (d) real interest rates not considered as major threat to savings, investments and flight of capital to non-financial assets and most importantly (e) need to step-up growth momentum from below 5% to above 6% to support fiscal consolidation. There has been a structural shift; fiscal consolidation is not seen as threat on inflation but growth pressures are emerging as threat for fiscal consolidation. All taken, there is need for RBI to shift its priority from inflation-control to growth-support and stay dovish on its monetary guidance. RBI’s concerns are from lack of policy reforms to spur growth and heightened political risk limiting the UPA Government in roll-out of reform process. The sustainability of current set-up of bullish cues is in doubt. There is no clarity from external cues as well; BRENT Crude and Gold has unwound most of its recent losses while turnaround signals in global economic recovery are not yet in sight. It may not be prudent for RBI to shift into loose monetary policy stance given these uncertainties. So, what to expect from RBI and its impact on markets?

RBI will deliver 25 bps rate cut and provide signals for some more limited space which should push the LAF corridor from  current 6.50-7.50% to 6.0-7.0% by end June 2013. So, it is a choice between front-loading of 50 bps rate cut now or phase it out in two stages; one on 3^rd May and next in June mid-quarter review. RBI may prefer to deliver in 2 lots sticking to its baby-step approach. The liquidity condition of the market is comfortable at around deficit of Rs.1 Trillion. The draw-down from LAF counter is mostly to refinance excess SLR book rather than to treat the same as overnight OMO bond purchases for credit expansion. While there is demand for CRR cut from most Banks (for bottom-line benefit), RBI’s preference is for SLR cut. The ideal situation with least impact on price stability will be for gradual move of CRR from current 4% to 3% and SLR from current 23% to 22% (total statutory holding down to 25% of NDTL). It may not be a surprise if RBI delivers cut in CRR or SLR or both aggregating to 50-100 bps to retain LAF drawdown within its comfort zone of 1% of NDTL deficit or surplus. These monetary actions will provide clear signals of RBI’s growth supportive stance and its comfort on soft-landing of inflation in the short term. It is important for RBI to stay neutral (to dovish) on its guidance; there may not be space for more rate cuts but option to shift system liquidity from deficit to surplus mode has room for fall in over-night rates by 1%. All told, monetary policy will stay supportive to growth (and asset markets) into the short/medium term.

The impact on asset markets will be neutral to mildly positive. There are no reasons to turn bearish given the dilution in conflict of play between growth-inflation dynamics. NIFTY should regain its pre 29^th January monetary policy high of 6111 for shift into short term trading range of 5800-6300. Rupee will stay bullish for recovery into post 29^th January monetary policy high of 52.88. It would position RBI to cover its earlier forward sale of dollars (at over $10 Billion), re-build its dollar reserves to earlier high of around USD 350 Billion and to maintain exchange rate competitive (and attractive) for exporters till economic recovery in western economies. RBI would be seen absorbing excess dollar supplies at/below 53.60-54.10. 10Y Bond has rallied sharply since September 2012 from 8.25% to 7.75%. While the medium/long term outlook is bullish subject to deliverables on various factors, near/short term outlook is neutral driven by demand-supply mismatch. The investor appetite for 10Y Bond at 7.60-7.75% may not be good when pipe-line fresh supplies are huge. The cut in HTM limit and resultant unwinding of long bonds will limit extended bull-rally in the Bond market. It is also in order for stability in 10Y Bond yield at 7.65-7.90% when overnight operating policy rate is expected to stay steady at 7% in the near/short term, thus building adequate tenor premium. The post-policy trading range is seen for NIFTY at 5800-6300; Rupee at 53.60-54.60 and 10Y Bond at 7.65-7.90. There are no strong cues for break-out either-way given the strong cross-winds in play; it would be period of consolidation in the short term while awaiting cues for directional guidance into medium and long term.

Moses Harding        

pre RBI monetary policy update

Need confidence boosters to revive bullish sentiment

The markets have gone through two phases since September 2012 change of guard at the Finance Ministry. Mr. Chidambaram promised policy reforms and fiscal consolidation; and markets gave thumbs up with hope and confidence on the way forward. NIFTY rallied from September 2012 low of 5215 to 6111 by end January 2013 by whopping 17% in 4 months. 10Y bond rallied from 8.25% to 7.80% for annualised return of over 24% and Rupee rallied from 56.03 to 52.88, up by 5.6%. However, the good fortune was short-lived and could not last beyond 4 months. Why the reversal of fortunes from end January 2013? The rally was built on hope that the worst is behind and delivery on fiscal consolidation will result in shift into favourable monetary conditions to attract investments and to build capacity expansion. RBI delivered the hammer in its 29^th January policy review by not signalling a soft monetary policy regime to support growth. RBI had reasons for it; with severe concerns on highly elevated Current Account deficit and retail headline CPI inflation. The markets reversed (to unwind most of recent gains from September 2012) pushing NIFTY down to 5540, 10Y Bond to 8% and Rupee to 54.90. What next? The markets lack clarity on immediate direction. The confidence of turnaround in macroeconomic dynamics is significantly diluted with political risks coming into the radar. Despite hanging on to minority coalition, the Government is seen to do its best on reforms and revival of infrastructure projects (and core sectors) which are critical to step-up growth momentum from below 5% to over 6%. Is this good enough to get back into bullish undertone? No. It would need RBI to do the rescue act. RBI is being pushed to the wall to shift its priority (and concerns) from inflation to growth. If it does by front-loading rate cut action and shifting system liquidity to surplus mode, then there will be a strong relief rally into levels seen in end January 2013. It is important for RBI to keep FIIs in play; if FIIs choose to exit, then it would take a long time to recover from the damage! What is the impact on markets till RBI’s actions? NIFTY is at risk of extending its weakness into post-Chidambaram low of 5215; and if FIIs choose to exit, then run-away weakness into 4770-5032 will be on cards. In the meanwhile, 10Y Bond finds solid support at 8% to post strong recovery into 7.90% on hope of FIIs shift of preference from equity to fixed income while USD/INR lost steam at 12M forward rate of 58.60-58.75 (high at 58.64 on spot at 54.89) for spot reversal into 54.60. What next? While we watch consolidation in 10Y Bond at 7.85-8.0% and USD/INR at 54.20/54.35-54.85/55.00, it is prudent to stay aside in equity assets. It is bit early to feel (and read) the pulse of RBI; a favourable stance from RBI will trigger rally in 10Y Bond below 7.78% (into 7.65%) and Rupee rally below 53.90 (into 52.90) while providing consolidation in NIFTY at 5800-6100. The strategy (into RBI’s annual policy) is to trade end-to-end of 7.80/7.85-8.0/8.05% (10Y Bond); Buy 1M forward dollar at/below 54.50 (spot at/below 54.20); sell 12M forward dollar at/above 58.60 (spot at/above 54.85) and stay away in equity assets allowing weakness into 5200-5400 to initiate strategic investments for relief rally into/above 5800.

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

Weekly report for 01-05 April 2013

MARKET PULSE: Weekly report for 01-05 April 2013

Comfort from Capital flows and better domestic fundamentals dilutes risks from elevated CAD

There are signs of nervousness from elevated Current Account Deficit (CAD); sharply up as percentage of GDP from 2.5-3.0% in 2008-2009 to 5.5-6.0% in 2012-2013. It is a combination of external and domestic cues that drove the CAD sharply up in 4-5 years; triggers are from bullish momentum in commodity prices, reduced external demand for India’s goods and services, higher consumption of subsidised essential imported commodities, risk-on investor environment pushing demand for non-essential imported commodities and contraction in domestic GDP growth. The sharp spike in CAD is not a surprise if we factor the changes in market (and economic) dynamics since 2008-2009; BRENT Crude is up from $36 a barrel to $125; Gold is up from $680 an ounce to over $1900 and GDP growth down from over 9% to below 5%. The pressure on CAD becomes worse on build-up of demand on trade imports while exports struggle to stay in business-as-usual mode. The impact is already felt in the system; tight system liquidity, elevated interest rates, high headline inflation and sharp fall in Rupee from 39 to 57.  The remedy has to be with combination of arresting imbalance in Trade Account, accelerating inflows from NRIs and off-shore investors, encouraging resident borrowers to access off-shore liquidity and ensuring rupee exchange rate stability through improvement in macroeconomic fundamentals to provide comfort (and confidence) to investors and borrowers to stay uncovered on foreign currency liabilities.

The Government is already working towards arresting demand for essential and non-essential imports through pass-through of subsidy and higher taxes while extending financial and non-financial support to exporters. Government is also on over-drive to attract inflows from NRIs through interest rate deregulation and rolling out red-carpet to FDI investors. All told, hot money flows from FIIs has helped to retain Balance of Payment in near surplus mode while high FX premium (and strong USD/INR at 54-56) continue to attract medium/long term dollar supplies from exporters/borrowers. While there are no quick-fix solutions to address the Trade imbalance, it is rather not difficult to address attracting inflows and achieving improvement in macroeconomic fundamentals leading to rupee exchange rate stability. The low-hanging fruits are (a) opening up leverage investments for NRIs and off-shore investors through attractive coupon rate (and removal of tax irritants) which would enable them to have cross-border asset-liability mismatch through liability leg in the off-shore and asset leg in the on-shore market; (b) increased access for resident borrowers to raise off-shore debt and (c) quick convergence of growth-inflation dynamics to turn monetary policy to support growth and fiscal consolidation. The worst is seen to be behind with consolidation in external factors and it is important to ensure exchange rate stability and remove risk of sovereign downgrade to bridge CAD with capital account flows till improvement is sighted in Trade account. All these factors have been factored into the exchange rate movements with strong support for the USD/INR at 53-54 and Rupee seen highly under-valued at 55-56. The break-out trigger of this range (of 53-56) will be on the outcome of steps taken to address CAD and retain positive Balance of Payment position at most times. Let not the importers/FC borrowers come in to hedge short/medium/long term foreign currency liabilities on fear of deterioration in CAD and the resultant run on the Rupee!

Exchange rate market:

USD/INR is in consolidation mode at 53.90-55.15. The strategy of MARKET PULSE was to cover 3M-10Y dollar assets/receivables above 55 and to cover 15-30 days liabilities/payables below 54. Given the consolidation mode of USD/INR, it is not considered prudent to pay high premium to acquire forward dollars beyond 1-3 months. This strategy covers USD/INR trading range at 53-56 in 2013 (already seen high of 55.38 and low of 52.88), thus giving enough time and scope to cover related market risks in FC assets and liabilities. What next? The base for USD/INR is already lifted to 53.90-54.05 (from earlier 52.90-53.05) duly pricing-in the macroeconomic fundamentals and the need for RBI to acquire dollars (and release rupees into the system) to balance inflation risks while retaining export competitiveness. On the other side, 55.10-55.35 is seen as the worst case for Rupee building space for improvement in fundamentals and high valuation of the dollar beyond 3M tenor. All taken, there are no strong reasons to act on the elevated Q3 CAD data print. For the week, let us watch consolidation at 54.20/54.35-54.85/55.00; test/break either-way will be excessive, hence not to sustain. MARKET PULSE readers are already covered in end April imports at/below 54.50 and in end June exports at/above 55.50 post the unwind of entire “short dollar” book at/below spot 54.10. It is now good for exporters to cover 6M exports at 54.60-54.85 (end September at/above 56.50); 12M exports at 54.90-55.15 (12M at/above 58.50) and 1 year-10 years (exports and shift of rupee loans into dollars) on extended rupee weakness beyond 55.15. There is no need for importers to panic till 55.15-55.40 is safe but stay covered on near term (7-30 days) on rupee gains into/below 54.15-54.40.

EUR/USD is in consolidation mode at 1.2750-1.2850 within set near term trading range of 1.2650/1.2750-1.3050/1.3150. The cues from the Euro zone are negative while economic recovery is being formed in the US zone thus extending rally in the USD Index from below 82 to above 83. For the week, let us watch consolidation at 1.2650/1.2750-1.2950/1.3050 with no strong cues to suggest break-out either-way. Having said this, bulls will be worried on extended weakness below 1.2650 which will then open up 1.2050 into the radar while there are no clear evidences to look for sharp rally beyond 1.3050-1.3150 at this stage.

USD/JPY is in consolidation mode at 93/94-95/96 post the sharp rally from 91 into 97. MARKET PULSE continues to retain its short term bullish undertone for 99-100 while above 93.00-93.50 preparing steam to take out 94.75-95.25 which is the trigger for extended gains beyond 96.50-97.00 into set short term objective at 99-100. The strategy is to trade end-to-end of 93.00/93.50-94.75/95.25 and to build “strategic long dollar book” for eventual rally into 99-100. There is minor risk of extended weakness below 93 to open up 90-91 before up again into 96-97.

Interest rate market:

10Y Bond has now completed end-to-end of 7.78-7.83 and 7.98-8.03. MARKET PULSE strategy was to sell 10Y (and beyond) at 7.78-7.80 and switch into 1-3 years to cut duration of the investment portfolio and to realise profits ahead of financial year end with intent to re-build investment book with longer tenor portfolio at 7.98-8.03 in preparation for movement in Repo rate to 7.0-7.25% during H1/FY14 to drive 10Y Bond yield to 7.60-7.75%. The end-to-end move has been rather swift as 10Y Bond fell from 7.78% (26/2) to 8.0% (26/3) in one months’ time. MARKET PULSE continues to stay with short term trading range of 7.65/7.70-8.0/8.05 factoring in demand-supply mismatch, investment appetite for fixed income assets, attractive “carry” on funding from LAF/CBLO counters and monetary policy actions. The strategy is to stay invested at 7.98-8.0 and 8.03-8.05% for near term objective at 7.80-7.83 and thereafter into 7.65-7.68%. If all goes well on macroeconomic fundamentals in H2/FY14 giving monetary bandwidth for RBI to shift the operating policy rate from higher end to lower end of LAF corridor, Bonds will extend its bull phase below 7.60-7.65 into 7.0-7.25%. FY14 is seen attractive for Bond (and fixed income) investments building space for 35-75 bps upside gains in the 10Y with limited downside risks (with stop above 8.07%); minimal risks with significant reward! For now, let us allow consolidation at 7.88/7.90-7.98/8.0 with test/break either-way to attract.

OIS rates into strong 1X5 play; 1Y rate is down from 7.65 to 7.45 and 5Y up from 7.13 to 7.28. MARKET PULSE strategy was to trade build-up of steepness in the 1X5 curve with 1Y received book at 7.60-7.65 and 5Y paid book at 7.10-7.15 with strategy to unwind at 7.45-7.50 and 7.28-7.33. All these have happened in matter of one month since mid February. The short term trading range is now seen at 7.15/7.25-7.50 (1Y) and 7.15-7.25/7.30 (5Y); meeting point for 1 and 5Y rate is expected to be somewhere at 7.25-7.30%. The strategy therefore is to build 1Y received book at 7.48-7.53% (for 7.30/7.10) and trade end-to-end of 7.15-7.25% in 5Y.   

FX premium is sharply down on spot date shift into FY14; 3M is down from above 8% to 7.5% and 12M marginally down from above 6.85% to 6.70%. While the bullish interest rate play stands diluted, exchange rate play will exert bearish momentum with objectives at 7% and 6.4% respectively. The strategy is to retain “received book” entered at above 8% (3M) and 6.85% (12M), add at 7.65% and 6.75% while watching trading ranges at 7.00/7.15-7.60/7.75 (3M) and 6.40/6.50-6.75/6.85 (12M).

Equity market:

NIFTY held at 5585-5610 short term support zone (low at 5605) to complete its reversal journey from above 6100 (high at 6111) in two months’ time. This completes end-to-end of set short term trading range of 5600-6100. The strategy of MARKET PULSE was to completely unwind investments at/above 6100 allowing sharp correction into 5600-5650. The cues are mixed with no signs of strong momentum to get into firm trend either-way. The risk factors are from domestic cues while strong FII appetite is retained, but weak macroeconomic fundamentals and lack of appetite from domestic investors keep downside risks (below 5600) in the radar. The investment appetite for domestic investors are strong in Fixed Income assets and there are no signs of shift of investments from Bonds to Equities in the near/short term as investors stay in wait for RBI’s 25-50 bps rate move for exit. Given these factors in play, it may not be easy to extend gains beyond 5850 into 5950-6100 in the near/short term. The near term trading range is seen at 5550/5600-5850/5900; test/break either-way is not expected to sustain. There is no great confidence to build strategic investments at this stage, hence prefer to stay fleet-footed trading end-to-end with tight stop on break thereof.

Commodity market:

Gold is in consolidation mode at 1590-1610 post the sharp fall from 1610 to 1555 and decent recovery thereafter. The cues are mixed between general dollar strength (against major currencies) and uncertain cues from the Euro zone as investors are unable stay firm either on risk-on mode or risk-off mode. MARKET PULSE preferred short term consolidation at 1500/1550-1650/1700 and have seen high of 1695 and low of 1555 so far and there are no strong cues to review this set short term range. In the immediate term Gold should stay below 1610-1620 resistance to retain its medium/long term bearish undertone for reversal into 1550-1500 to pull 1300 into the radar. For now, let us watch consolidation at 1560/1575-1605/1620 and await cues to build break-out bias.

NYMEX Crude extended its rally from 89.50-90.00 support (low at 89.33) into strong resistance at 97.50-98.25 (high so far at 97.80). The tone is bullish for extended gains above 98.25 to pull 100.42 into the radar to complete 100% recovery of recent fall from 100.42 to 89.33. At this stage, there are no major risk factors to prefer extend rally into 105-110. The near term trading range is now seen at 94.50/95.00-97.75/98.25 not ruling of break of 98.25 for deeper extension into 100.00-100.50 which should hold. The strategy is to buy on dips for the said rally while strategic players can look to sell in two lots at 98.00-98.25 and 100.00-100.25 (with stop at 100.50) for reversal into 90 to set up short term trading range at 90-100.

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