MARKET PULSE - 18 NOVEMBER 2011

18^th November 2011

Currency market

Rupee was in consolidation mode at 50.50-51.00; generating good supplies at 50.90-51.00 (in anticipation of RBI’s support) and attracting good demand at 50.65-50.50 (shorts squeeze from uncovered importers). RBI was also seen selling forward dollars in the shorter tenor (January-February) to prevent extended weakness beyond 51.00. In the meanwhile, USD Index was in two-way sideways trading mode at 77.50-78.50 (but it is matter of time to see retest of recent high at 79.84). The short term fundamentals for rupee are weak with risk of NYMEX crude settling above 100 and NIFTY below 4700. There is no clarity from the Euro zone and even on roll-out of aggressive support measures; it may not result in release of dollar liquidity squeeze in the domestic system. As said, there is not a single positive factor in favour of rupee at this stage (except RBI’s token presence to cushion excessive one-way move) and there is clear formation of medium term base around 49 (sharply up from 39 since January 2008 and 44 since July 2011). For now, we stay put with expectation of short term consolidation at 49-52; not ruling out the possibility of shift into higher base (of 50 or 51) into the medium term. The strategy now is for importers to hedge 3-6M payables in two lots on spot gains into 50.65-50.50 and 50.15-50.00 while exporters stay aside for spot weakness into 51.75-52.25 to cover 6-12M receivables. There are no cues to expect strong reversal in rupee below 50 at this stage and chance of visit into historic high of 52.17 is on cards. It may not be to RBI’s dislike if rupee could settle into consolidation mode at 50-52 till positive cues emerge from external sector. For today, let us continue to look for two-way sideways trading mode at 50.65-51.10 with overshoot limited to 50.50-51.25.

EUR/USD failed at resistance zone of 1.3550-1.3650 but holding well at immediate support zone of 1.3400-1.3425 while USD/JPY is in consolidation mode at 76.75-77.25. No change in strategy as we await EUR/USD move into 1.3150-1.3000 and USD/JPY reversal into 79-80. The strategy for now is to sell EUR/USD at 1.3550-1.3650 for 1.3150-1.3000 and buy USD/JPY at 76.75-76.25 for 79-80. While short squeeze in EUR/USD is expected to provide support above 1.3350; it would be matter of time for extension into 1.3150 while bounce from there will find 1.3450-1.3500 difficult to crack. It is possible that we move into near term consolidation at 1.30-1.35 till more cues come in to set up the directional break-out.

FX premium has nicely traded end-to-end of 5.5-6.0% in 3M and 3.5-4.0% in 12M before close at 5.6% and 3.8% respectively. While the interest rate play continues to exert upward pressure; exchange rate play has turned neutral. There is no risk of test/break of higher end till dollar liquidity is back into the system which is seen as low probability occurrence at this stage. So, let us continue to stay with the set range with strategy to fund PCFC book through rupee resources absorbing 3M premium at 5.85-6.0% and pay 12M at 3.65-3.50% for interest cost advantage through conversion FC sources into rupee uses. The relaxation of FII limits in Government and Corporate Bonds without restriction on residual maturity will keep the bullish undertone intact in the longer end. The risk of break higher will be on rupee test/break of historic high at 52.17 which could trigger 3M into 7.0-7.5% and 12M into 5.0-5.5%; hence need to be cautious there. Strategic players can now revert to 3X12M play by paying Jan-Oct at 3.25-3.10% (125-119) for near term target at 4% (155).

Commodity market

NYMEX/WTI crude moved into the sell zone of 99-102 but did not have the momentum to take out the stop at 103 for reversal back into 98. In the absence of strong cues to set up momentum either-way, it would be prudent to look for consolidation at 95-105. Let us stay fleet footed to trade this range by buying at 96-93 and selling at 102-105 with tight stop on test/break thereof. Gold has now traded end-to-end between set resistance/sell zone at 1780-1810 and support/buy zone at 1710-1680. The downward momentum is high tracking higher sovereign yields across the Euro zone. There has been selling across all asset classes to stay in cash. This is the risk factor to trigger test/break below 1680. Let us now shift our attention for consolidation at 1680-1760 and await more cues for setting up directional break-out.

Bond/OIS market

Most targets met; 1Y bond yield sailed into 8.85% and 10Y bond has now traded end-to-end of set 8.75-9.0%; giving good entry around 9% and exit at below 8.80%. The announcement of OMO to prevent extended weakness in 10Y bond above 9% was not a surprise. But, it would not be prudent to expect the bond market getting into bull phase given the negative factors in play; at this stage there is not a single positive factor to get into aggressive buy mode and would rather wait for higher yield pick-up in RBI’s week-on-week auctions. The purpose of OMO is said to bring down the draw down from Repo counter which is sustaining around Rs.1 Trillion despite moving into reporting Friday. The shift into new reporting fortnight; pipe-line bond auctions; advance tax outflows; shift of foreign currency credit to rupee credit and demand for funds from Banks are some of the factors that will keep the pressure on liquidity for extended period. Let us continue to watch 1Y around 8.75-8.90% and 10Y at 8.75-9.0% with immediate term bias for move into upper end. The strategy is to play end-to-end as test/break either-way is not expected to sustain. OIS market moved perfect to the script; to complete end-to-end move of the set near term range of 8.10-8.35% (1Y) and 7.25-7.50% (5Y). Here again, there is no conviction to look for test/break either-way; hence continue to watch sideways trading mode within these set ranges. The bond swap spread of 75 bps in 1Y and 160 bps in 5Y will provide support and possibility of RBI shifting into rate cut mode soon will limit extended weakness. Let us continue to stay fleet footed playing end-to-end moves of the set ranges with tight stop on break thereof. Having said this, the risk is for extended run into 8% and 7.10% respectively which will form a very strong base for shift into consolidation at 8.0-8.25% and 7.10-7.35% into the short term.

Equity market

NIFTY extended its weakness below 5000 for close at 4934; thus setting up a firm bear run into play. Now, there seems to be confirmation of slippage in growth momentum below 7.5% into 7.0-6.5% in the medium term. Moreover, tight liquidity (and higher short term interest rates) into end December will add to downward pressure. Over all, test/break of 4850 into 4700 is just matter of time. We now watch 4700-4950 and set exit levels of 4800 and 4700 for shorts initiated above 5350 with trail stop at 5000. Strategic investors to stay away for the test of lower end of set medium term range of 4700-5700 to initiate one-third of investment appetite. There is no clarity (and conviction) to expect strong reversal from 4700 at this stage; hence do not rule out extended weakness below 4700 when we would set our next entry levels for strategic investors. Fleet footed traders can sell at 4950-5000 with stop above 5050 for 4750-4700.

Moses Harding