Monetary Policy Expectations - Special Report by Dalal Street Investment Journal

India Money Market : mid 2015 review

Steady decline in short term rates against hardening long term yields

RBI delivered 3-baby steps rate cut pushing the operative Repo rate from 8% to 7.25% in H1/2015, shifting to accommodative monetary policy stance to be growth supportive backed by trend down in CPI inflation into its tolerance zone of 4-6%. RBI formula was also made known to stakeholders, to maintain 1.50-2.0% spread between CPI and operative policy rate. This sets up the need to retain Repo rate as operative policy rate till CPI come at ease at lower half of 4-6%. As a first step, RBI cut the refinance availability at Repo counter against excess SLR held by Banks. The previous 100% entitlement at overnight Repo counter is squeezed and spread over to term Repo counter. This strategy to avoid build-up of surplus system liquidity retained Call money rate between Repo and MSF rate, currently at 7.25-8.25% with intent to resist trend down in Call money rate into LAF corridor, now at 6.25-7.25% while CPI stays at 5-6%.

The impact of rate cut was surprise to many; while short term Treasury Bill yield trended down from 8.10-8.35% to 7.35-7.60%, previous 10Y benchmark 8.40% 2024 yield spiked up from 7.50-7.65% to 8.0-8.15%. In the process, inverted yield curve got shifted into upward sloping curve. It served the desired purpose of bringing the lending rates down (through lower short term money market rates) while keeping long term yields (at elevated level) attractive to foreign investors to retain them from staying invested in India. What next?

FED rate hike versus RBI rate pause in H2/2015

FED stance is now clear for shift into rate hike cycle on or before Q4/2015, so is RBI signalling no rate cut in 2015 with January 2016 CPI outlook at 6%. So, Repo to stay as operative policy rate through rest of 2015 despite infusion of liquidity through $ purchases. RBI has already shown the way to  sterilise the excess liquidity through OMO bond sales. While there is good comfort on easy short term money market rates, demand-supply mismatch will exert upside risk on long term Gilt yields. Banks are already holding huge excess SLR at 28-30% of NDTL against mandatory 22%. The aggregate of FY16 bond auctions and OMO sales may not be met with desired demand appetite. However, higher "carry" at 75 bps extend solid support for 10Y bond at 7.90-8.0%, seen as worst case scenario. On the other side, FED rate hike against RBI rate pause in H2/2015, price appreciation into 7.70-7.80% is tough to sustain. Both combined, 10Y bond is seen to be in bearish consolidation mode at 7.80-7.90%. Based on this view, has already set 7.72-7.75% as duration-cut zone and 7.90-7.93% as duration-build zone and have seen back-and-forth move here more than once.

The set strategy is retained for rest of 2015 given the better clarity on the way forward. 10Y benchmark 7.72% 2025 focus retained at 7.72/7.75-7.90/7.93% not ruling out breakout bias into 8.0%. The strategy is to build book (and duration) at 7.90-7.92% and 7.98-8.0% for 7.71-7.73% and 7.63-7.65%, likely to be seen in H1/2016. The attractive "carry" against limited downside risk on value depreciation sets up good risk-reward investment opportunity.

Bearish consolidation is the preferred outlook

RBI is seen to have locked the short term focus at 7.78/7.80-7.90/7.92% through accelerated bond supplies at lower end through regular and OMO supply and not accepting bids beyond the higher end. The probability of rally beyond 7.78-7.80% into 7.72% is limited given the need for RBI to stay in $ buy mode to arrest Rupee appreciation beyond 63. It will be also against the interest of the Government to allow yield spike beyond 7.90-7.92% into 8% to incur higher cost on market borrowing to fund fiscal deficit. All combined, outlook for rest of 2015 is for stability in Call Money rate around Repo rate (seen steady at 7.25%), 91-364 T-bill yield at 7.35-7.60% and 10Y benchmark yield at 7.78/7.80-7.90/7.92%. This stance is seen good to retain CPI at 4/5-6% and Rupee stability at 63-65. The strategy is straight forward, to play end-to-end of 7.78/7.80-7.90/7.92% in 2015 and to build portfolio at 7.90-8.0% for 2016 rally into 7.65-7.72%.

Moses Harding

India Currency market : Mid 2015 review

Rupee in bullish mode maintaining price stability

Rupee is not far away from 2014 close of 63.03, despite huge foreign currency reserve build-up by RBI. This means that Rupee has not even adjusted for the 6M interest rate differential of around 7.5% between INR and USD, which is around Rs.2.35. The intra-2015 play is also restricted at 61.29-64.30 (between end January to mid June at door-to-door rate of 4.9%, not significant to call it as volatile). Rupee stability despite USD Index DXY up from 2014 close of 90.27 to over 100 (current at 97.50) is reflective of global optimism on India. Rupee gain against Euro is more visible at 10% from 2014 close of 76.25 to current 69.00 against intra-2015 low of 65.67. But for RBI absorbing excess foreign currency supply, USD/INR would have been way below 60!

The India market stake-holders can't ask for more! Importers and foreign currency borrowers have not lost staying unhedged gaining the time value. Exporters too got a good opportunity to cover medium/long term foreign currency assets on USD/INR spike above 64.00 for double benefit of price appreciation and time-value decay. RBI in $ buy mode provided better Rupee value for foreign investors. RBI took the pain of paying the interest rate differential (near-zero $ return against over 7.5% Rupee sterilisation cost) to keep Rupee value competitive to exporters and attractive to FII/FDI investors. All taken, it has been a glorious period for Rupee in H1/2015 before July stability at 63.35/63.40-63.65/63.70. What next?

Minimal impact from external headwinds

Rupee is seen strong to stay resilient to external headwinds. The bullish momentum in DXY into/and over 100 and risk of liquidity pull-out post FED rate hike act are not significant risk factors now. Availability of Euro zone liquidity, large appetite for India opportunities from other major economies and improved confidence of RBI to defend Rupee provide comfort through rest of 2015.

Domestic cues positive despite growth concerns

The structural benefit for India is the sharp decline in CAD from 4-7% of GDP to 1-2% with hope of turning CA neutral or surplus in the medium term. The CAD deficit means export of domestic capital for consumption of imported items. While this export is permanent in nature, funding the deficit through capital inflows is temporary, subject to exit any time. This structural imbalance is permanent risk on the Rupee exchange rate. The risk on exchange rate also cut the bandwidth of RBI to reduce interest rate significantly on fear from foreign capital repatriation. India opportunities to global investors will gain speed going forward attracting huge FDI inflows in the months/years ahead. FII appetite for India assets will stay valid in the absence of opportunities elsewhere. Rupee loss of traction with DXY rally gives exchange rate advantage for short term FII investors. So, combination of trend down in CAD and sustainable foreign currency inflows are huge positive for Rupee on the way forward. The risk however is from sudden downside shift of Rupee value, which importers and short term foreign currency borrowers should be mindful of. The sudden re-rating of USD/INR value is not uncommon, many importers have taken real loss with exporters losing on missed opportunity. All combined, Rupee price stability with bullish undertone is there to stay valid through rest of 2015, and adjustment if any will be lower than interest rate differential time value. On an end to end basis for 2015, USD/INR at 67.50 is break-even value on interest rate differential adjusted basis, without considering USD strength against global currencies. As Rupee remain steady against the USD while other major currencies decline, stake-holders need to be cautious on non-USD exports given the steep appreciation risk of Rupee against Euro, GBP, JPY etc in 2015.

Will RBI review range against huge supplies?

Post the Rupee recovery from 64.30 to 63.30, RBI has set administered range at 63.30/63.35-63.65/63.70 to ring-fence USD/INR exchange rate from news flows from Greece to enforce price stability. In July, there has been 4 sets of back-forth moves into the outer corridors. Now that Greece crisis is about to be resolved, it is high time RBI release its firm grip on the exchange rate. If done, immediate impact will be extension into 63.00-63.20 with shift of range focus from 63.30-63.70 to 63-63.50. However, retain set rest of 2015 strategic focus range at 63/63.35-64.65/65 with near term zoom-in focus at 63/63.15-63.85/64. Taking comfort from RBI both-way presence, importers are out (avoiding payment of time value) and exporters are in to absorb elevated FX premium, thereby creation of huge oversold $ position. This is the big risk in play now if lumpy PSU $ demand hits the market; break of 63.70 will shift RBI administration at 63.50-64.00. All combined, it is bias neutral between 63-63.50 and 63.50-63.70. RBI preference however would be for stability at upper-half of 63.30-64.30 to arrest Rupee getting into over-valued territory hurting exports and FDI flows.

EUR/INR at mid point of set strategic focus at 65.50/66-73/73.50; urged exporters to cover medium/long term receivables at higher end to ride the price appreciation and time value, also remember to have urged RBI to cut Euro reserves by selling EUR/INR instead of USD/INR when RBI was seen to sell $ for Rupee protection at 64-64.30 while EUR/INR at 72-73. The bearish undertone for EUR/USD is intact at 1.0450/1.06-1.0950/1.11 against USD/INR sideways mode at 63-64. Both combined, EUR/INR trading focus is seen at 67/67.50-70/70.50 with bias into lower end. FED shift into rate hike mode in Q4/2015 against ECB QE mode through 2016 sets up risk of revisit to 65.50-66.00 before end of 2015.

Moses Harding

India Equity Market : Mid 2015 review

Shift from roller-coaster ride to stability mode

Good news first, NIFTY is above 2014 close of 8282 and Bank NIFTY above 2014 close of 18736. However, it is relief (and not cheer) with recovery from intra-2015 June low of 7940 (17174) post the big sell-off from intra-2015 March high of 9119 (January high of 20907 and March high of 20541). The roller-coaster ride was restricted at set hot-to-hold zone 9000-9150 (20650-21000) and value-buy zone of 7950-8100 (17000-17350), and now around mid-point of the set strategic trade zone for 2015. What next? It is relief that risk build-up of NIFTY stretch weakness below 7950 (into 7500-7650) and Bank NIFTY below 17150 (into 16000-16350) is cut for pull-back over mid-point 8550 (and 19000).

Global cues stay uncertain providing mixed signals

India derived benefit from the economic slow-down in the Euro zone and China to emerge as the most favoured investment destination for FIIs in the BRICS and emerging markets category. The near-zero interest rate regime in the US also helped to a great extent diverting money to high yielding debt and value-buy equity assets against minimum exchange rate risk. While downside risk from the Euro zone and China is minimal, FED start of rate-hike cycle in Q4/2015 is significant risk in play, putting pressure on domestic interest and exchange rate for transition into the equity market.

Domestic cues continue to stay in growth-inflation conflict mode

While worry from twin-deficits is behind, risk on growth and inflation stay valid. The benefit from stable outlook in Brent Crude at $45-70 post Iran resolution and weak Gold for move below 1130-1145 support zone are positive on the CAD, but the beneficial import from export growth is not yet sighted. All taken, CAD is seen in comfort zone at 1-2% with more than adequate net flows through Capital account, thus giving better comfort on Rupee exchange rate stability. RBI in $ buy-mode is good for infusion of domestic liquidity for downside pressure on interest rate. The risk from fiscal deficit is behind with combination of higher revenue receipts and cutting slippages. It is high probability that FY16 fiscal deficit will be better than target of 3.9%. Inflation is worry point as CPI trends into wrong side of 4-6% tolerance zone. On the other side, GDP growth target of over 8% is seen tall, with most estimates around 7.5%. Both combined, Indian economy continue to struggle with low growth - high inflation mode. Despite this conflict, RBI delivered 3-step 75bp rate cut in H1/2015. The 4th step in H2/2015 is tough to come by when RBI CPI outlook is high at 6%. The NaMo euphoria is also diluted against absence of political unanimity on policy initiatives. All combined, investor appetite (both domestic and foreign) is low despite liquidity over-hang. So, there are no clear signals for set up of bullish momentum over the March 2015 high seen in NIFTY and Bank NIFTY.

Neutral consolidation is the way forward

Given the mixed impact from domestic and global cues, consolidation is the best way forward. The uncertainty is from options between bullish consolidation in NIFTY at 8550-9000/9150 (Bank NIFTY at 19000-20650/21000) and bearish consolidation at 7950/8100-8550 (17000/17350-19000). The other options between downside risks below 7950 (17000) and upside reward above 9150 (20650/21000) is kept outside the radar at this stage in the absence of strong cues either way. All taken, retain the set 2015 strategy and maintain NIFTY at 9000-9150 (Bank NIFTY at 20650-21000) as hot-to-hold zone and 7950-8100 (17000-17350) as value-buy zone.

Immediate term outlook lacks clarity

NIFTY seen to be firm above mid-point of set 2015 strategic range (at 8550), so is Bank NIFTY at 19000. The directional bias is dependent on hold here for bullish consolidation at 8550-8850/9000 or sustainable break of 8550 setting up bearish consolidation at 8100/8250-8550. For the short term, good to keep 7950 and 9150 out of focus. Bank NIFTY hold above 19000 is good for bullish consolidation at 19000-19850/20200 while sustainable break of 19000 sets up bearish consolidation at 17800/18150-19000. So, need to fix attention on NIFTY at 8550 (Bank NIFTY at 19000), and now that it is at lower end of 8550-8850/9000 (19000-19850/20200), bulls will be in buy-dips mode into 8550/19000 while bears await break here. The immediate resistance at 8640-8665 (19250-19350) is under pressure for bullish extension towards 8850/19800, which may hold for 8250-8850 (18800-19800) short term consolidation.

Moses Harding

Whatz ahead post Greece referendum? Not a make-or-break event!

ECB choice between near term pain and long term agony

Despite Greece contribution to the top-line balance sheet of Euro zone or Global economy is miniscule, too much of hash tag significance has been given to #Grexit and #Greferendum in the social media by economic & financial markets analysts. And, markets have been in back-and-forth mode driven by news flows either in favour or against. First, the focus was on the 30th June IMF loan repayment default and now on the outcome of the referendum.

Come what may, global (and emerging) markets have nothing much to gain or lose! The gain or pain will stay within Greece and the Euro zone. Greece has more to lose or gain than the Euro zone, and the Greece Government is short of cash to get out of this crisis. Greece is now like a NPA borrower, seeking restructuring of existing debt with hair-cut (on amount & interest rate) and long gestation period to start the repayment process. Greece voters would be aware of this hard reality, post the recent curbs on its financial system. While a "YES" vote will be immediate relief to keep the negotiations alive, a "NO" vote will be disastrous, and major setback to creditors putting them on back-foot.

It would need the Euro zone heavyweights (Germany and France) to do lot of financial sacrifice to avoid #Grexit now or later. While the setback (from "NO" vote preparing for #Grexit) will be near term driven by sentiment, the relief may be long term to shift focus away from Greece towards stabilizing the growth offshoot. There will be near term weakness, but investors will see this as value-buy long term opportunities. There has been decent correction in the Euro zone equity markets with minor push-back in the US. It is possible that downside risks from here is limited. The interest rate market has been steady around mid-point of recent low and high, and it is possible that overshoot either way beyond here may not sustain. The currency market has also been steady; DXY marginally up from 93.50 to 96.50, driving the Euro down from 1.1450 to 1.0950 before stability around 1.11. The impact on the commodity market is not very significant; Brent at ease from below $70 to $60 and Gold didn't benefit from the risk-off stance with gradual decline from above $1200 to $1160. A "YES" vote will lead to dilution of nervous undertone while improving investor sentiment (if not the confidence), but this does not imply that the markets will get into run-away bullish momentum. In the absence of clarity on "What Next?" and the final outcome, upside gains will stay limited. All taken, there will be knee-jerk reaction, up or down before stability, retaining neutral (to mildly bearish) undertone on the way forward.

Global markets shift focus away from Greece to macro fundamentals

DJIA trading focus for 2015 has been at 17000/17150-18350/18500, and now around mid-point. The set zoom-in focus at 17500/17650-18000/18150 has held well against #Grexit volatility. Now, risk from early front-loaded rate hike by FED during September - December 2015 is seen to be diluted with shift to later part of Q4/2015. This is immediate relief to keep investors in risk-on mode riding the liquidity and low interest rate regime for some more time. All combined, stretch weakness if any below 17500 ahead of strategic support at 17000-17150 is good risk-reward buy opportunity for revisit to 18350-18500.

10Y US Treasury yield is around mid-point of set 2.20-2.60% focus. It is bias neutral for near term stability either at 2.20-2.35% or build rate-hike fear for consolidation at 2.35-2.60% till better clarity on the timing. The strategy is to stay in focus at end-to-end of 2.20/2.30-2.50/2.60%.

DXY in volatile mode in 2015; in bullish mode from above 90 to over 100 before consolidation at 93/93.50-97.50/98.00. Now, need to be prepared for Euro driven volatility; into 98-100.50 on Euro weakness into 1.05-1.0650 and into/below 93.00 on Euro recovery into 1.1350-1.15. The strategy is to stay fleet-footed at 1.05/1.0650-1.1350/1.15 against caution from Central Bank's support at/below 1.08-1.0950.

JPY derives safe-haven support (as alternate to USD) against downside risks on the Euro, with USD/JPY unwind from below 126 to 122. While recent high of 125.85 seen to be intact, downside risks on USD/JPY below 121.85-122.35 comes into focus for deeper correction into 120-121 before stability. The strategy is to stay focused at end-to-end of 120/121-125/126.

India markets shift undertone from bearish to neutral

India financial markets have unwound recent weakness, staying resilient to #Grexit and Euro zone woes. NIFTY posted swift recovery from 7950 to 8500, so is Bank Nifty 17200 to 18750. 10Y bond yield remained volatile at 7.67/7.70-7.90/7.93 with back-and-forth moves before settle around 7.80%. Rupee unwound recent weakness from 63.45 to 64.30 and now at 63.35-63.50. The supportive tailwinds are from better than expected monsoon and positive external factors from recovery in Brent Crude from $70 to $60, US economic data not in favour of front-loaded FED rate hike and crash in Chinese markets. All combined, the dilution of risk from FII early exit and possibility of RBI rate cut in H2/FY16 have emerged as positive cues for Indian financial markets.

No clarity (and confidence) as yet to turn bullish, hence into consolidation phase

Should NIFTY focus retained at 7950/8000-8450/8500 (Bank NIFTY at 17100/17250-18700/18850)? A "YES" vote on #Greferendum will lead to extension into 8635-8685 (19100-19250) before stability, while "NO" will lead to direct unwind of recent recovery for 8185-8235 (17800-17950) seen as strong near term support zone. Combination of both sets up trading focus at 8150/8200-8500/8650 (17850/18000-18750/19100) with caution against overshoot either way, which is not expected to sustain given the mixed outlook both on domestic and global cues.

10Y bond at mid-point of short term strategic focus set at 7.67/7.70-7.90/7.93%. It is neutral bias here, but appetite will be low at 7.67/7.70-7.80% and huge value-buy interest at 7.90/7.93-8.0%, seen as extremes for rest of 2015/FY16. So, need to be fleet-footed to trade the 7.70-7.80% play. The other option is for yield spike into higher end of 7.80-7.90%, which is tough to hold with RBI in stand-by support. Both combined, set focus at 7.72/7.75-7.87/7.90% and overshoot either way not to sustain.

Rupee firm at lower end of set strategic focus at 63/63.35-64.65/65.00, while RBI prevented weakness into 64.65-65.00 with good $ supplies at 64.20-64.30 and 63.90-64.00, it is also expected to have large appetite at 63.35-63.45 and 63.10-63.20. Now, let us stay focused at 63/63.35-63.95/64.30 with most trades at inner-ring. It is prudent to stay risk-neutral at either end with near term import hedge and short/medium term export cover.

Have a great and safe week ahead!

Moses Harding