Financial markets in sharp unwind from signs of running out of stock on monetary steriods
Global markets got the benefit of monetary steroids since 2009 with major Central Banks pumping in huge system liquidity through QEs in various innovative forms while shifting the cost of liquidity from near zero to NIRP regime. In the absence of QE and NIRP impact on inflation, it provided larger bandwidth for Central Banks to stay in ultra-dovish stance for extended period of time. Most investors caught on to this opportunity and resultant euphoric appetite resulted in building huge valuation in risk-on financial assets over 2008-2013 base. It was not a one-way street and it had many bouts of value correction, before injection of next dose of steroid to pump the markets up again. This liquidity triggered valuation need to be supported by growth momentum for sustainability, which unfortunately didn't happen. The worry for Central Banks (and investor community) is the absence of impact from monetary steroids on macroeconomic fundamentals. The liquidity driven valuation will only stay as "bubbles" in the absence of catalyst support from growth, employment and consumption led investment. Why is the sudden turn of fortune in 2016? It is obvious that US and China economies have to be in high gears for stability in global financial markets. China losing the momentum was visible in early 2015 while US showed signs of recovery, and FED put end to QE and prepared the markets for H2/2015 start of rate hike cycle. Till then, it was bias neutral on financial markets with DJIA in sideways mode at 15350-18350, US 10Y yield at 1.85-2.35% and Gold crashing down from 1300 to 1050. The investor sentiment was boxed between risk-on and risk-neutral with few signals for shift of mode to risk-off and risk-aversion.
The turn of event in 2016 is the doubts over US economic recovery, when other heavy-weight economies China, Japan and Euro zone have moved from bad to worse. The economic data from the US were not good enough for FED to stay on course for follow-on rate hikes in 2016. These turn of events (more QE from China & the Euro zone, Japan into NIRP regime and FED into extended rate pause) undid the US optimism support to financial markets driving DJIA down from 17350-18350 bullish consolidation range to risk-off range at 15350/15500-16350/16500 and US 10Y yield sharply driven down from 2.20-2.35% to 1.50-1.65%. Combination of risk-off on equity, low Gilt yields and negative return on cash drove Gold value sharply up from $1035-1050 to 1200-1250. USD also lost its interest rate advantage for DXY push back from higher to lower end of 95-100. All combined, investor sentiment moved down hill from risk-on to risk-neutral and now mixed between risk-off and risk-aversion.
India status shift from preferred to stay aside from domestic cues not turning to expectation
While external cues shifted from tailwind support to headwinds resistance, domestic cues turned from euphoria to hope to verge of disappointment with fear of worst. Despite clear political mandate to Modi (and BJP), political irritants remain as serious hurdles to economic reforms and prosperity. There are lot of uncertainties ahead with no clarity on the way forward. India GDP growth in struggle around 7.5% and await GST roll-out for step up over 8%. The fiscal deficit wish-target at 3.5% by March 2017 is ambitious. CAD has lost its price advantage from Gold and the Brent, both showing signs of worst is behind. The existence of supply bottlenecks against higher demand is price-push on inflation, making it tough for RBI to ensure CPI soft landing at/sub 5% by end FY17 without being cautious on monetary policy stance. All combined, with Government in cross-roads and RBI short of ammunition post injection of overdose rate cut steroids in 2015, India status as most favoured financial markets is no more relevant as FIIs are already on the lookout of alternate destinations. MARKET PULSE strategy in FY16 was reflective of this shift of dynamics, both external and internal. During this phase, NIFTY trading focus got reviewed down from 7500/7650-9000/9150 with 2016 down-hill chase from 7965-8000 to 7000-7035. The outlook was bearish on Banking stocks for deep down-hill chase from 20650-21000 to 14000-14350. India Gilts didn't derive benefit from risk-off in equity with 10Y bond yield up from 7.45-7.50% to 7.88-7.93% from duration-cut play. During this phase, Rupee gave up 68.85 to 58.35 recovery between July 2013 - May 2014, and now back at 68.35-68.85. It is tough call on India financial markets when external appetite is on decline and domestic support is thin from pain and fear. All taken, while most investors missed the rally from Feb 2014 to March 2015 built on Modi euphoria and external beneficial impact on CAD and inflation from lower Brent Crude price, most incurred huge real loss and/or opportunity loss on the March 2015 - February 2016 crash.
India equity valuation is not bad to ignore
Nifty below 7000 and Bank Nifty below 14000 is not a good exit for those who have already absorbed the impact from 9000-9150 and 20650-21000 respectively. So, the choice is between hold or accumulate. While investors may be ok to accumulate over the entry made during August 2013 - February 2014, it is tough for those who entered between March - October 2015 to prefer accumulate over hold. However, It is easy decision for investors who are in cash (taking money off the table) and risk-off mode since March - October 2015.
India equity market behaviour is seen in traction with DJIA at 15000/15350-16500/16850. At this stage, probability of bullish shift to 16850-18350 is low with bias for test/break of 15350 into 13750-14000, seen as strategic value-buy base for 2016. Given this outlook, NIFTY near term focus is set at 6500/6650-7000/7150 with neutral bias between 5950-6100 and 7500-7650. Bank NIFTY having led the fall in FY16 will look to regain the excessive value-erosion. Having said this, it would take a while to get into risk-on mode. The focus for now is set at 12650/13000-14000/14350 with neutral bias between stretch into 11000-11350 and 15350-15700. The negative take-away is the lower shift of 2016 high in Nifty from 7965-8000 (January) to 7600-7635 (February) while in search of 2016 base for sustainable recovery. It would be relief for February hold at 6500-6850 for close at 7150-7500 ahead of Budget 2016. The ball is held by the Government to prevent equity assets unwinding completely the Modi advantage.
India Gilts retain bearish undertone against most cues against sustainable recovery
India 10Y bond retain its struggle at 7.80-7.93% despite ease in US 10Y yield from 2.20-2.35% to 1.50-1.65%. But for this move, 10Y bond might be trading at 7.85-8.0%. There are no positive triggers from domestic cues with near-zero bandwidth for rate cut when RBI continue to stay suspect on inflation and fiscal deficit against emerging downside risk on the Rupee. The demand-supply dynamics in the absence of external appetite will also lead to pressure. What Next?
Given that US 10Y bond retain stability at 1.50/1.65-1.80/1.95% based on expectation of FED rate pause in March, India 10Y bond 7.72% 2025 is seen in bearish consolidation mode at 7.80-7.95% (7.59% 2026 at 7.68-7.83%). MARKET PULSE continue to hold 7.75-7.80% as duration-cut zone and 7.90-8.0% as duration-build zone. The pity is that post 50 bps September 2015 rate cut, duration-cut zone is moved up from below 7.50% to 7.60-7.65% to 7.75-7.80% between October 2015 - January 2016.
Rupee has more pain (and less gain) despite attractive forward rate
Rupee shift of play from 65.85-66.20 to 68.50-68.85 is swift triggering importer's panic (on unhedged $ liabilities) and exporters fear (on mark-to-market on covered receivables) with depreciation of over 2 Rupees against time-decay of less than 50 paisa from start of 2016. The worst part is that despite DXY consolidation at 95-100, USD/INR retained upward bias and would have punched all time high but for RBI $ supply at 68-68.50. MARKET PULSE was positioned for 66-69 trading range for Q1/2016 not ruling out stretch into 70 in FY17; ahead of time is indeed scare for many. The strategy to hedge 1-3M imports/FCL at spot levels from 66.10-66.25 and 66.55-66.70 and 12M exports at 72.50-73 has worked good chasing the 12M USD/INR in 2016 from 70.25-70.50 to 72.50-73. What Next? The big-picture rest of FY16 is now tuned at 67.70/67.85-68.85/69 (12M at 71.75/72-73/74) and it would need miracles for Rupee recovery into 66-67.50 with high probability for stretch into 68.50-70.00. Don't know what is RBI upto when domestic liquidity squeeze and pressure on short term money market rates have not helped Rupee stability. MARKET PULSE continue to retain 12M USD/INR at 73+ as good to stay between risk-neutral and risk-off through hedge of 50-100% of earnings risk. USD/INR spot at 68.50-70 and 5-10Y India-US yield spread at 6-6.15% is good for shift of Rupee liabilities to USD for resident borrowers and off-shore debt investors.
EUR/INR chase from 70 to 77-78 is more than break-neck speed with shift of focus at 75.50/75.85-78/78.35. The end of chase from 70 is based on outlook of heavy EUR/USD at 1.1350-1.15 and Rupee support at 68.20/68.35-68.50. What Next? Now, with EUR/USD near term play seen at 1.0850/1.10-1.1350/1.15 and USD/INR at 68-69, watch EUR/INR resistance zone at 78-78.35 against support at 75.50-75.85, breakout eitherway is not expected to sustain.
Have a great week ahead and Good luck!
Moses Harding
harding.moses@gmail.com
9674734145
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