India markets in consolidation mode; Is the relief permanent?

Is the worst behind for India markets?

India Financial markets was stuck by Tsunami from China, opening up downside risks on global economic growth and fear of FII pull-out from Emerging Markets. The worst hit was India equity assets and Rupee exchange rate. The intra-August crash in Nifty was sharp from 8621 to 7667, so is in Bank Nifty from 19103 to 16670 before modest recovery into 8091 and 17569 respectively which couldn't hold building bearish momentum at 7950 and 17000. The said moves are more or less to the script; MARKET PULSE set NIFTY overshoot target through 7950-8000 into not beyond 7500-7650 short term base for consolidation at 7950-8100. Bank NIFTY was seen to crash below 18000-18100 into 16600-16750 base before consolidation at 17000-17650. In the meanwhile 10Y Bond 7.72% 2025 has traded back-and-forth at 7.73-7.93% before consolidation at 7.75-7.80%. Rupee met the value adjustment target of 66.60-66.85 (low at 66.76) from set USD/INR strategic base of 63-63.35 (low at 63.30), while 12M $ shot up from 67.75-68 to target 71-71.50 b4 consolidation at 70-71 (spot at 65.85-66.50).

The recovery in domestic markets is lead by sharp recovery in global markets; DJIA held at set 15100-15350 support (low at 15370), seen as strategic base to hold sharp reversal from recent high of 18350 (door step of 18350-18500 strategic resist and hot-to-hold zone). US 10Y yield also held at 1.95-2.0% for recovery into 2.20%. USD Index DXY held at 92.50-93 support for recovery into 95-96.50. All was good to dilute the pent up bearish momentum, but not seen to be well as yet to get into bullish momentum.

What next? Sentiment mixed between risk-off and neutral in wait-and-watch mode

All is not well in the short term against suspect global cues. The tailwind support from external cues is now behind. The best hope is for dilution in Tsunami kind of headwinds from the China and the US. China monetary and exchange rate moves (seen as steroid boosters to hold its exports competitive to EM peers) is not seen to be over as yet. US start of rate hike is only seen to be delayed within target time line of September - December 2015. The comfort however is from RBI shift into dovish monetary policy stance and confidence on the stability of the macroeconomic fundamentals, with concerns only on the GDP growth trend into higher side of 7-8% target. Both combined, India is seen to perform better than other EMs - most seeing India as the best amongst the worst. Is this sentiment good enough to attract offshore appetite on India markets? Or only good enough to limit reverse flow? All taken for short term, investor sentiment (and confidence) is not in favour to set up bullish momentum for rest of 2015. While staying risk-off is extremely conservative, it may be prudent to see rest of 2015 for value-buy for resumption of bullish trend on shift into 2016. The game on India 2015 was over in Q1 and Q4 is the position build phase for 2016.

Equity markets undertone mixed between nervous external cues and comfort from domestic cues

India equity markets continue to stay nervous from impact of next steps from PBoC and rate hike action from the FED. Both combined will not be easy to absorb, notwithstanding pipeline rate cut from RBI. For now, retain focus in NIFTY at 7500/7650-8100/8250 (Bank Nifty at 16500/16750-17500/17750). The break out bias is mixed but seen not beyond 7000/7150-8500/8650 (Bank Nifty at 15850/16100-18850/19100), significantly below the Q1/2015 high of 9119 and 20907 respectively. It is possible that 2015 low may get punched during Q4/2015, where strategic value buy interest would emerge for 2016 bull run. For now, it is good to keep September Nifty focus at 7500/7650-8100/8250 (Bank Nifty at 16500/16650-17500/17650) with most trades at inner ring in sideways mode, while extension into outer corridor will be tough to sustain for long.

India Gilts retain consolidation mode

India 10Y bond has already seen multiple back-and-forth at set big picture focus at 7.73-7.93% with failure at duration-cut zone of 7.68-7.73%. The comfort however is from hold at value buy zone of 7.88-7.93% zone. While there is confidence on long term hold at 7.90-7.93%, cues are mixed on sustainable bullish undertone at/beyond 7.70-7.73%. While RBI dovish monetary policy stance stay in support for short term consolidation at 7.68-7.78% post 25 bps rate cut (with most trades around par value 7.72%), extent of impact from FED rate hike is not clear. All combined, continue to retain short term focus at 7.68/7.73-7.88/7.93% with most trades at inner end. For now ahead of 29th September policy review, stay focused at 7.72/7.75-7.80/7.83% with bias into lower end before back-and-forth consolidation.

Rupee is due for minor downside value adjustment before stability

USD/INR adjustment from 63-63.35 to 66.60-66.85 is done; thereafter, correction mode held at door step of revised base at 65.50-65.85 for consolidation at 65.85-66.50. What next? Most cues do not suggest shift into Rupee bullish momentum as yet, given the fear factors from importers and FIIs in the short term retaining near term focus at 65.85/66.10-66.85/67.10, not ruling out stretch into 68.85 before stability at 65.85-68.85. The hedge strategy is for importers to stay risk-off (or neutral) upto 3 month exposure at lower end, while exporters to look at 6-12M cover at 67.35-68.85 (12M $ at 72-73). All combined, long term strategic focus is retained at 65/66-69/70 through rest of 2015 and on shift into 2016. For now, September play is not seen beyond 65.60/65.85-66.85/67.10, with RBI protection at either end.

EUR/INR has been explosive on break out of 68.65/69.15-71.65/72.15 consolidation range for spike into 78-78.50 before push back to 73.50-74.50. The upside bullish momentum is largely from USD/INR (up from 63.35 to 66.85) against volatile EUR/USD at 1.10-1.15/1.17. What next? EUR/USD bias beyond 1.10/1.1050-1.15/1.1550 is not clear with good comfort on USD/INR near term stability at 65.85/66.10-66.85/67.10. Combining these, the near term focus is at 72.65/73.15-76.65/77.15 and good to stay focused at end to end.

Moses Harding

India Financial Markets: Near term outlook

Gloom and doom back to haunt global investors and markets

Global financial markets weathered the storm from the FED and ECB quite well, but China delivered tremors on the Emerging markets and bearish momentum on risk-on global markets, first from the collapse of its equity market followed by currency devaluation. China growth declaration is worry for developed markets, but the recent currency devaluation measures (to boost China exports) is sudden blow to Emerging Markets who are in hurry to adjust their exchange rate value to counter Chinese moves to protect their top line balance sheet. FIIs are caught on the wrong foot in the cross fires, unaware and confused on the way forward - to hold or exit or add! It was sudden and unexpected, when all was looking well post relief from Grexit and dilution of FED rate hike impact on markets given the ultra-dovish monetary policy in rest of the developed markets.

Sentiment in risk-off (and stay away) mode

DJIA sharp downside break of 17000/17150-18350/18500 stability (and consolidation) zone and US 10Y yield under pressure at lower end of 2.0-2.40% and Gold recovery from 1170-1185 to 1260-1275 are not positive take-away for the way forward. The worry is from set up of pessimism on the global economic growth, pressure on unemployment and consumption. While investors chase risk-off sovereign assets, Brent is sharply down from $70 a barrel to $45 on fear of demand compression ahead. The risk on Emerging markets is seen from the USD strength against EM currencies while losing steam against major currencies, building risk of flight of capital from EMs to home markets. All taken, China triggered shock waves on Emerging markets is there to stay for long, pushing global investors to run for cover into return-home mode.

DJIA intra-week crash (of over 1000 points) from 17568 to 16459 is bearish for 15850-16000 with resistance zone now at 16850-17000. Investor risk aversion mode build fear for extended run into 14850-15350. US 10Y Treasury yield is set to crack below 2.0% into its long term base at 1.75-1.90%. It may be a high risk chase to stay "long" at 1-10Y spread below 1.5%. FED may need to defer its rate hike stance to end 2015 or beyond into H1/2016. Gold also benefits from the mood-swing diluting bearish momentum and turning bullish for complete recovery of 1220-1235 to 1070-1085 fall, triggered by rate hike fear and resultant USD strength. Gold is now seen firm into 1200-1235 with support base at 1135-1150. Brent has punched a new 2015 low at 45.07 below January low of 45.19, retaining bearish momentum into December 2008 low of 36.20, completely unwinding the multi-year rally from here to March 2012 high of 128.40.

What is in it for India markets?

The only positive cue for India is the bearish momentum on essential import of commodities. While Brent Crude stability at $35-50 is good for the CAD and inflation, higher Gold price at 1135-1235 and weak Rupee at 65-70 knocks out some benefit. The concerns however is a big list from growth, fiscal deficit, foreign investor appetite and dilution of hope from domestic policy initiatives to spur growth momentum beyond majority forecast for FY16 GDP growth at 7-7.5% against target of 8-8.5%.

We have already shifted NIFTY focus at 7950/8000-8350/8400 (and Bank Nifty at 17100/17250-18100/18250) not withstanding delivery of 25 bps rate cut on or before 29th September policy review. While the trend is down, will global headwinds gain speed to trigger new 2015 low below 7940 (17174)? This probability is not ruled out now.

10Y bond relief from 7.90-7.93% is in struggle to extend gains beyond 7.73%. While 7.68-7.73% is set as duration-cut zone, surprised to see weakness from here extend beyond 7.78% in an otherwise risk-off investor mode. The fear is obviously from the FIIs stance now - to hold or exit or add. The worry is also from sudden shift of Rupee value from 63.35 to 65.85, causing rate cut delay till Rupee stability at 65.60-67.10. Nevertheless, current India-US yield spread at over 5.65% (current at 5.73%) is good to prevent FII exit. The domestic appetite will be good not for hold, but for rate cut action as demand-supply equilibrium continue to stay against. But, over long term, 10Y bond yield is biased for move into lower end of set FY16 strategic trading range of 7.65-7.90%. We have already seen back-and-forth here, and there are no cues now to drive sustainable breakout either way. For now, it is high risk to chase weakness beyond 7.78% and rest of FY16 trading range is now squeezed at 7.65-7.80%.

USD/INR is at striking distance of target 66.50/66.65-67 from set strategic base of 63-63.35. The rally from 63.30 to 65.92 was at break neck pace with weekly close at 65.83. While near term consolidation is seen at 65.65/66-66.65/67, do not rule out extension into all time low of 68.85 seen in August 2013. Confirmation of this will be on close above 67.10. RBI will be in supply mode at 66.60-67.10 to retain stability at 66-67, while watching next steps of China. The risk is also from USD back into its bullish rhythm against major currencies with possible DXY hold at 93-93.50. All taken, near term trading range is not beyond 65.60/65.85-66.85/67.10, overshoot either way not expected to sustain. For now, retain 12M $ focus at 69.75/70-70.75/71 for long term hedge strategy.

Rupee is down badly against the Euro from combination of Euro strength against the USD and Rupee weakness against the USD. EUR/INR is sharply up from set  68.65-69.15 base to 74.50-75 on spike in EUR/USD from 1.08 to over 1.1350 and USD/INR up from 63.35 to 66. What next? EUR/USD has broken out of set strategic focus at 1.08/1.0850-1.13/1.1350 after series of back and forth moves and looks set for extension into 1.1450-1.1550 (DXY base at 93-93.50). Rupee weakness into 66.60-67.10 against Euro strength into 1.15-1.1550 sets up next target for EUR/INR at 76.50-77 with support at 74.50-75. Need to be cautious on sudden reversal of Euro against the USD. For now, set focus at 74.50/75-76.50/77 and be prepared for downside break out into previous resist zone of 72.65-73.15.

All combined, India Financial markets will stay under pressure from Tsunami kind of headwinds from external sector against limited domestic fire power to ring fence the external impact. The only positive take away is the lower Brent Crude below $50, unaware of how long it would last. Domestic cues are not very supportive given the downside revision on GDP growth target at lower end of 7-8% against slow down in policy initiatives. There is too much of smoke without fire at this time, which is serious worry for domestic stakeholders and external investors.

Tighten your belts for rough weather ahead!

Moses Harding

Time to strengthen domestic macros to ring fence from external impact

Risk from the US and fear of China

India financial markets volatility is mostly driven by external cues. It is also true that most times it is extremely bullish or nervously bearish. The impact is largely from high dependence on off-shore funds (and demand for India goods & services) and over dependence on import of essential items. The import of non-essential imports (as alternate to domestic production) is also growing because of cost (and value) effective foreign products. More the dependence on off-shore markets, higher is the risk of extreme bouts of volatility! In the globalisation era, it is essential to look (and move) outwards for top-line capacity build. The need however is to have a good balance between domestic and external avoiding high dependence of one over the other. Countries who built their economy from exports to developed markets are facing the heat on significant squeeze in consumption. Countries who set up huge manufacturing capabilities to build domestic production (for exports) are under pressure from sub-optimal capacity usage. All taken, countries who built domestic consumption (and investment) for optimal capacity build and used external liquidity (and demand) for top up capacity expansion stand to withstand difficult times. The ability to withstand the downturn is what matters in the survival of the fittest global scenario.

Indian economy (and financial markets) faced the major risk from the FED preparedness for start of rate hike cycle, building fear from reverse flow of off-shore liquidity and resultant pressure on Rupee exchange rate and inflation. This also meant that monetary policy cannot turn accommodative to growth. The major relief for India was from sudden and significant reversal in prices of imported commodity items, releasing pressure on the Current Account Deficit. NaMo euphoria helped to dilute the risk from fear of off-shore reverse flow.

When India had sigh of relief from FED pipe line move on rate, China currency devaluation emerged as major threat. The comfort that India got from sharp decline in CAD (supported by robust off-shore flows) is at risk, when FED prepares for September rate hike. Although China provide assurance of no more currency war, more devaluation steps in the short/medium term is not ruled out. Asian (and EM) currencies have adjusted their currency value to stay competitive with Chinese exports. India cannot stay different, else be left alone. India has problems in many, while the GDP growth base is pegged firm at 7-7.5%, it is not easy to get into sustainable momentum into set medium term target of 8-10%. It is good that fiscal deficit and inflation has come into control with minimal downside risk beyond set tolerance level. The issue now is on retaining CAD stability at 1-2% and to hold the off-shore appetite for India, while ring fencing significant reverse flow. Till the Government strengthen the domestic macros, the said risk could only be managed through Rupee exchange and interest rate (with surplus system liquidity) till resolutions to address structural woes are put into execution for desired results.

Build India for higher domestic consumption and work towards Current Account efficiency

China has aligned its monetary policy stance to support export driven growth. The measures leading to availability of abundant liquidity at low interest rate and undervalued domestic currency are already triggered, with more in pipeline. While the structural woes on fiscal deficit and inflation are seen to be behind for India, serious concerns emerge from growth and Current Account deficit. The monetary policy has to turn supportive for execution of "Make for India" (to build domestic consumption) and "Make in India" (to boost exports) themes.

With greater comfort on inflation and fiscal deficit, it is high time for RBI to stay supportive to growth and arrest risk on the CAD through export boost. The 3-point agenda for RBI is clear now: (a) deliver 25 bps rate cut ahead of 29th September 2015 policy review (b) administer USD/INR exchange rate stability at 65-67/70, preferably at upper-half and (c) shift operating policy rate from Repo to Reverse Repo rate or deliver over 25 bps rate cut.

All these are not good enough to push GDP growth momentum from 7-7.5% to 8-10%. Government should quickly remove the risk of set up of policy paralysis through execution of critical policy reforms, managing the political resistance judiciously. Combination of RBI monetary policy support and Government initiatives to ensure policy execution can restore the confidence on the Indian economy for set up of bullish momentum on India financial markets.

Let us hope for the best and stay hopeful (and positive) on India asset markets.

Moses Harding

In conversation with The Global ANALYST...August 2015 Issue

Is RBI ready for pre-policy rate cut? Good time to act now!

Calls to cut policy rates get louder

There is pressure from the Government and wholesale borrowers for more (and accelerated) cuts in policy rates. The borrowers logic is based on their inability to compete with off-shore peers where the cost of funds is very low. The huge difference in interest cost (between on-shore and off-shore markets) cut their competitiveness adding pressure on top-line capacity building. True, makes sense!

On the otherside, the Government is not keen to retain the interest rate advantage play to off-shore investors for extended period of time. It is fact that leveraged off-shore flows gets into the system for the elevated yield spread against Rupee exchange rate stability. The system has witnessed sudden bout of weakness from herd-unwind of such fair-weather hot money investor community. This time, most stake holders are seen to be ok with sudden bout of weakness, seeing this as blessing in disguise to attract stable value-buy long term investments, while seeing Rupee depreciation (reflecting fair valuation) as good for exporters. Given the benefit from Brent Crude stability at $45-60 and dilution in risk of CPI stability at higher end of 4-6% tolerance zone, Rupee impact on inflation can be easily absorbed if significant benefit accrue to boost exports and replace hot money with stable FDI inflows. So, when twin-deficits and Rupee exchange rate are not seen as structural woes on inflation, seen against sharp soft landing of July CPI below 4-6% tolerance zone (at 3.8%), there is indeed strong case for delivering token 25 bps rate cut now, ahead of 29th September policy review.

Dream-come-true July CPI print is manna from the heaven

None would have expected the July CPI print at 3.8% below the set long term tolerance zone of 4-6%. Most stakeholders opined risk of stability at higher end at 5.5-6.0% in the short term. RBI was also in this crowd with January 2016 target at 6% and March 2016 at 5.8%. Against these estimated outlook, CPI at 3.8% is great relief (to counter the China Exchange rate actions). Even if some critics see this in disbelief and tough to sustain, positive take away is from expectation shift from 5-6% stability to 4-5%. This scenario sets up operating policy rate (now Repo) range at 6-7% at higher end of RBI stated target of 1.5-2.0% spread between policy rate and CPI expectation. Even if RBI wishes to wait and watch through September awaiting August CPI print and mid September FOMC meet (on FED start of rate hike), it can well afford to wait post delivery of 25 bps rate cut, reducing the Repo rate from 7.25% to 7.0%.

While this act is not seen as a significant beneficial impact for borrowers, it is good for RBI in many ways.10Y bond yield stability at 7.70-7.85% is good for smooth conduct of rest of FY16 Government borrowing schedule and conduct OMO bond sales to arrest excessive decline in medium/long term yields. The build-up of steepness in the overnight-10Y sovereign yield curve at 7.0-7.75% may not hurt retail investor community. All taken, a cut of 25 bps now (may be, this Friday as Independence day gift to the nation) is the way to go!

Impact neutral on markets

The Indian markets are weak both from domestic and external cues. China currency war to support export-driven economy is not going to stop; more devaluation to come! On the domestic cues, while there is great comfort now from twin-deficits, growth concerns remain given the struggle to push key policy initiatives. Add to this, the downside risk on the Rupee will make FIIs look for exit door from India (and emerging) markets for safe return home. The rate cut now will help to dilute this bearish momentum for price stability.

All cues taken, pre & post rate cut range is seen for NIFTY at 7950/8100-8500/8650 and BNF at 17100/17500-18700/19100. An early rate cut will provide stability at upper-half of set ranges; while a delayed one, post move into the lower end (of the inner-ring) will get the focus at lower-half of set ranges. At this point, expectation of rate cut is holding NIFTY at/above 8315-8350 (Bank NIFTY at 18000-18100), while a delay could extend the bearish momentum into 8100 (17500).

USD/INR move into higher end of 64.50-66.50/67 is seen good for adjusting the Rupee over valuation to fair-value to remain competitive for India exporters (against China onslaught) and attractive for fresh flow of FDI flows into India.

India 91-364 T-bill yield shift to 7.15-7.40% is good to get the shorter end of the yield curve down for benefit of borrowers, which would improve demand (and consumption) for higher capacity usage and expansion. 10Y yield stability at 7.70-7.85% is good for the Government (lower cost on borrowing), long term retail investors (yield stability despite rate cut) and RBI (for smooth conduct of pipe line auctions).

Why wait, then? Get it out on 14th August!

Good luck, tighten your belts for price volatility!

Moses Harding

Should RBI Governor have the veto power on the monetary policy?

Collective decision is the best way in a public enterprise

There has been heated debate post issuance of draft FLC frame work on RBI Governor's role on monetary policy decisions. Most believe that the Finance Ministry is working to shift the veto power from RBI Governor to the Finance Minister. This fear is valid when the majority in the committee are Government nominees, who are seen to act from the whip of the powers that be!

The democratic process in India do not support provision of veto power to any individual in the public domain. From this view point, it is good to go with the majority decision without overriding powers to any individual. The veto power is not available to the Heads of Central Banks in most countries. So, when India follows the foot steps of established developed economies in setting processes and good governance, why not in this as well? It is good that the RBI Governor endorses this view point.

Will the committee think and act independent?

The problem in India is always at the execution level. So, doubt arises on the extent of freedom available to the Government nominated members or others cleared by the Finance Ministry. The problem arises from the habit of echoing His/Her Master's Voice in order to retain the position, which brings to the forefront the personal interest over the public interest. Two options to clear this negative perception: The Finance Ministry to stay away from the Monetary Policy decision making giving complete freedom to the committee or appoint members who are seen to be independent, come what may without the desire to hold on to this coveted position if any decision is forced on them.

The strategy to move into democratic, collective and majority decision making process is great. But, it should reflect at the execution level to make it effective and efficient.

Is Arun Jaitley hearing?

Moses Harding

RBI Monetary Policy review : retain balancing act between growth and inflation

RR stood firm on inflation control

RBI delivered to expectations keeping policy rates unchanged taking comfort from affordable cost of short term sources of funds. Given the abundant system liquidity, RBI chose not to cut CRR and SLR in the absence of desired demand for use of funds.

RBI retained FY16 growth target at 7.8%, bit unrealistic though, but stayed cautious on inflation retaining January 2016 outlook neutral at 6.0%. RBI did send positive vibes from setting March 2016 CPI target at 5.8%, stance seen as cautiously optimistic on the way forward with limited confidence. It is non-event with no clear guidance on the way forward, hence the post policy price stability. While the rate cut hope is retained, the timing of the next rate cut is anybody's guess between October 2015 to March 2016 if not beyond. One thing is seen for sure, chance of rate cut in October - December 2015 is remote against January - March 2016 CPI target at 6.0-5.8%, already at 1.25-1.5% spread against Repo rate of 7.25%. The best case is for Q1/2016 if January CPI eases below 6%, building case for review of March 2016 target at/below 5.5% creating bandwidth of 25 bps cut ahead of end FY16. This is however dependent on Brent Crude stability at $45-60 and firm Rupee at 63.50-64.50. By then, FED would have delivered 50 bps rate hike. All combined, it is not a great-feel policy despite providing feel-good outlook of ease in CPI inflation beyond January 2016.

The positive take away however is the pipeline efforts to strengthen the financial system to ensure smooth flow of liquidity to funds starved core sectors of the economy. The focus on capital infusion, NPA resolution and efforts to dilute credit risk aversion is immediate need of the hour. All taken, RBI has reinforced its comfort on liquidity and cost of liquidity while taking desired steps on diversion of liquidity from risk-off Gilts/AAA corporate debt/investments to risk-on infrastructure, manufacturing and agriculture sectors, which is critical to guide step up growth momentum over 8% by end of FY16.

Limited clarity ahead on markets - bulls and bears on crossroads

The policy tone leaves neutral undertone on markets. Retain NIFTY focus at 8400-8650 (within 8250-8850) while 7950 and 9150 is distant away from the radar. Bank NIFTY gets RBI and Government support for shift into higher range focus at 18500-19500 not ruling out downside bias into 18000.

India 10Y bond is under pressure from shift of RBI rate cut beyond October 2015 and FED start of rate hike by September 2015. The demand - supply dynamics is also not in favour in the short term. Both combined, 10Y bond is seen in bearish consolidation at 7.80-7.90% for now.

RBI is stuck between devil and the deep sea in management of Rupee exchange rate. While there is need to retain Rupee exchange rate competitive to exports and attractive to long term inflows, managing excess Rupee liquidity is emerging as serious irritant. Liquidity injection through spot USD/INR purchases is tough to be sterilised through OMO bond sales. Purchase of forward dollars cause upward pressure on short term money market rates from elevated FX premium. The only comfort for RBI is from firm DXY at 96.75-100 which would arrest Rupee gains not beyond 63.60-63.75 for push back to 64.20-64.35. The risk of Rupee weakness into 64.65-65.00 stands diluted now.

The domestic cues to watch now are growth momentum, and external cues from Brent Crude price stability at 45-60 and FED timing on start of rate hike. All taken, cues are mixed to take a firm and confident view on the immediate direction on the markets. It is prudent to stay focused on set consolidation ranges for end to end play with stop on break out either way.

Moses Harding

RBI 4th August policy review: Expectations and impact analysis

Better comfort on inflation than ever before

It was a shocker on the previous 2nd June review when RBI set a hawkish tone with January 2016 CPI target at 6% (higher end of the 4-6% long term tolerance zone) against risk of Brent Crude price rise beyond $70 a barrel into 85 and downside pressure on Rupee exchange rate into 65-67. The monsoon worries and resultant supply side issues exerting pressure on CPI was concern for RBI. The FED rate hike outlook in September pushed US 10Y yield into higher end of 2.20-2.60% was seen as external risk in play. All combined, it was prudent for RBI to stay in caution without sending unrealistic (and optimistic) guidance.

Between 2nd June to 4th August, all cues have turned for better. Brent Crude shifted focus from 70-85 to 45-60, Rupee is firm at 63-65 comfort zone despite USD strength (against global currencies), US 10Y yield down at lower end of 2.20-2.60% and Gold is down from over $1200 to below 1100. The sharp 20% fall in Brent Crude and 12.5% ease in Gold (and sustainable bearish undertone through 2015-2016) takes out the structural woes on inflation from elevated Current Account Deficit and downside risk on Rupee exchange rate. There is also great comfort on fiscal prudence beyond FY16 from growth driven higher revenues and better efficiency on cost-revenue management plugging slippages on revenue collection and cost optimisation. All taken, RBI has now long term comfort on twin-deficits and Rupee exchange rate which were resistive for shift into dovish monetary policy stance. The risk from higher US yield retaining the medium/long term India yields at elevated levels is blessing in disguise to build steep upward sloping money market curve to provide cost efficiency to borrowers at shorter end of rate curve and yield advantage to investors at the longer end of the curve. The resultant excess demand for funds at shorter end and abundant supply at longer end will lead to price stability exerting squeeze in the money market rate curve. It is win-win dynamics for all stakeholders.

The positive impact (from downtrend in twin deficits and stability in Rupee exchange rate) on inflation is significant; risk of CPI beyond 6% is near zero and probability of ease into lower end of 5-6% in FY16 is high before shift into 4-5% in FY17.  The only worry in the radar is the monsoon impact on food prices, and the Government is seen committed to bridge the demand-supply gap to give RBI the desired comfort. All taken, the inflation outlook is positive than ever before!

Guidance shift from hawkish to dovish building rate cut hope in H2/FY16

RBI has no option but to tone down its hawkish tone of 2nd June. While retaining the January 2016 CPI outlook at 6%, it is in order to build optimism signalling worst case scenario of 6% for improvement into 5-5.5% by March 2016 into FY17. This outlook with build 25-50 bps rate cut in H2/FY16, between October 2015 to March 2016. The outlook is for 25 bps cut in Q4/2015 and follow-on 25 bps cut in Q1/2016. The sentiment ahead is positive for retaining operative policy rate at 7.25% for now with downward bias into 7% in Q4/2015 on CPI outlook at 5-5.5% by end FY16. There after if CPI retains momentum for easing further into 4-5%, RBI has the option to either push Repo rate down to 6.75% or shift the operating policy rate from 7% to 6% (lower end of LAF corridor) through shift of system liquidity from deficit to surplus with CRR cuts or aggressive USD purchases and OMO bond purchases. Till now, RBI has taken a balanced stance through 75 bps rate cut in H1/2015 to support growth and sterilisation of surplus system liquidity through combination of refinance restrictions at Repo counter and OMO bond sales to control inflation. Most cues have now turned in favour to shift stance from neutral (and balance) mode to more accommodative stance.

India financial markets mixed between inflation relief and growth worries

RBI money market policy stance will turn supportive to financial markets in the medium/long term. The short term concerns are from downside risks on FY16 GDP growth momentum with most expectations around 7.5%, significantly below the aspiration target of 8-8.5%. The euphoria from expectation of giant-steps big-bang policy reforms is behind and the momentum is seen to be in baby-steps, seen as chicken feed against voracious appetite. The investor (and lenders) ability to fund growth is high but the appetite is low from risk aversion. The risk-reward trade off is not seen to be in favour to make money chase investment and lending opportunities. The Government is making efforts to pull appetite from private investors through higher budgetary allocation for investment in infrastructure and core sectors. These efforts lead to dilution of pessimism but not seen as good enough to build optimism in the short term through FY16. All combined, the make-or-break factor is the ability to set up growth momentum building positive outlook for stake holders to revise outlook from below 7.5% into 7.5-8.0%. At this stage, FED preparedness for shift into rate hike mode in September 2015 is not seen as major hurdle, and India financial markets seen resilient to absorb upto 50 bps hike in rest of 2015. If by then India CPI shift to stability mode at 4-5%, FED rate hike over 50 bps in 2016 may not seen as resistive headwind.

India equity market in neutral consolidation mode in the short term

While downside risks seen limited with interest rate and liquidity support, upside gains from here may not be significant against earning pressure from baby-steps capacity expansion. The financial services sector is under serious trouble from deterioration in asset quality, low credit pick up and limited upside from investment book, all leading to earning pressure and low profitability. The capital infusion in PSU banks is seen to keep them afloat rather than to fund top line balance sheet growth. All taken, the low seen in 2015 is safe with not enough bullish momentum to post a new high. NIFTY 2015 range has been at 7950-9150, and now in indecisive mode around mid point 8550. Given the mixed cues between inflation comfort and growth concerns, it would be in order for neutral consolidation at 8250-8850 for rest of 2015. Beyond here into Q4/FY16, bias is neutral between bullish shift into 8850-9150 or slide back to 7950-8250.

Bank NIFTY rest of 2015 range is seen at 17850/18000-19850/20000, and now heavy above mid point of 18850-19000. The short term outlook is for neutral consolidation at 18350-19500 for rest of 2015. Beyond here into Q4/FY16, bias is mixed between bullish shift into 19350-20000 or slide back to 17850-18500.

Money market yields at ease in the shorter end and steady in the longer end

The short term play is seen in the 1x10 Gilt yield spread, seen to widen from current 25-35 bps to 50-65 bps. While short term (3-12M) Treasury Bill yield trend down into lower end of 7.15-7.50%, 10-15Y Bond yield seen steady at 7.70-7.85%. This outlook covers uptrend in US 1Y yield spike into higher end of 1.0-1.25% and 10Y into 2.35-2.60% with India-US yield spread around 6% in 1Y and at 5.15-5.65% in 10Y while CPI stay ease at 5-6%. The downside risk on India Gilts is also driven by huge pipeline auctions (and OMO) supply against low investor appetite from Banks adjusting the excess SLR book with incremental requirement from top-line deposit growth. All combined, rest of 2015 range is seen restricted at 7.0-7.50% (3-12 month) and 7.70-7.85% (10-15 years). The strategy is to stay invested at higher end (with positive carry funded from Repo/CBLO counters) while not chasing gains below the lower end.

Rupee fortune boxed between RBI $ appetite and exporter/investor supply

USD/INR has been in administered mode at 63.30-64.30 with bids from RBI (and 1M import hedge) at lower end and supplies from RBI (and 1-12M export cover) at higher end. The play was in perfect traction with MARKET PULSE trading (and hedging) range of 63.20/63.35-64.20/64.35. The focus was also reviewed up at 63.60/63.85-64.60/64.85 in alignment with DXY recovery from lower to higher end of 93-98 and covering time decay. Given the demand-supply dynamics in the forward market between upto 1M $ bids from importers and 1-12M $ supplies from exporters, Rupee is not vulnerable to sharp downside risks in rest of FY16 with focus not beyond 63-65/67. While the bulk $ supply in cash market will be absorbed by RBI, any lumpy demand (from PSUs or FII pull-out) will be used by RBI for time decay value adjustment. The need is to administer Rupee value to stay competitive to exporters and attractive to sustain long term inflows (avoiding hot money exit). All combined, Rupee impact from divergent monetary policy actions of RBI and the FED may not be significant or excessive. It is good to retain short term focus at 63.85-64.85 and stay risk-neutral (or off) at either end with short term import hedge at lower end and short - long term export cover at higher end tracking 1M USD/INR at 64-65 and 12M at 68-69, overshoot either way not to sustain.

EUR/INR strategic focus range at 68.50/69.50-72/73 held well against sideways play in EUR/USD at 1.08-1.13 and USD/INR at 63.30-64.30. Given the near term focus in EUR/USD at 1.08/1.0850-1.11/1.1150 against USD/INR at 63.85/64-64.50/64.65, EUR/INR focus is set at 69.50/69.75-71/71.25, not ruling out downside bias into 68-68.50. It is prudent for exporters to stay covered across 1-12M at/above 71 encashing time value and hedge against short/medium term bearish undertone.

Good luck and have a great week ahead!

Moses Harding