Currency market
Rupee has now moved into uncharted territory above 52.18 to post all time intraday low of 52.73 and all time daily close low of 52.30. The reversal from intraday low into 52.30 was triggered by late evening news of RBI meeting oil PSUs dollar demand from its books while the traction with correction in EUR/USD (from 1.3470 to 1.3550) and in NIFTY (from 4780 to 4850) was low. What next? We have already shifted into a new near term range of 51-54 with next objectives at 53.50-54.00. The USD Index is in bullish mode despite weak US fundamentals. This is mainly on build up of economic; monetary and fiscal pressures on the Euro zone with no signs of roll out of concrete rescue packages. It is also believed that it is matter of time before France and Germany get sucked into Euro zone woes. It would need strong outperformance of Euro zone over US zone to get rupee back into its bull phase; which is not on cards right now. Therefore, it is important for RBI to think different to dilute rupee bearish undercurrent; as rupee weakness beyond 52 (and into 54-56) will hit the economy very hard. It is essential to get the focus back into 49-52. Having said these, we need to see how effective RBI’s measures would be to counter strong USD Index (weak EUR/USD) and weak equity market. While RBI’s actions will provide bit of comfort to rupee bulls; it is important for EUR/USD to hold its weakness above 1.3350-1.3425 support zone and NIFTY above strong support zone of 4675-4725. There will also be issue from widening arbitrage between offshore NDF and onshore OTC; creating demand for dollars. 3M NDF dollars is already trading at premium of over 30 paisa which is attractive and easy money. While we watch impact of RBI’s action on rupee; the market is expected to stay volatile in the immediate term within 51-53. Strategy for importers is to cover 6-12M payables on spot gains into 51.50-51.00 while exporters stay away for 52.75-53.25 to cover 1-3M receivables. The risk factor to RBI’s measures will be from NIFTY weakness below 4700 and EUR/USD fall below 1.3350; which are high probable occurrence. We will also await measures from RBI such as deregulation of FCNR/NRE interest rates; lifting the “cap” on off-shore borrowing limit for Banks; issuance of rupee denominated corporate bonds to overseas investors; open up USD counter to Banks to fund PCFC etc. These measures will be more effective than RBI’s physical intervention or direct selling of dollars to oil PSUs. Opening up of access to FII/NRI investor community into long term corporate/infra bonds could do little to help rupee at this stage; no investor will wish to take cross-border exposure without currency hedge. Other than being dependent on EUR/USD and NIFTY factors (for reversal in bearish set up on rupee), it is important for RBI to infuse dollar liquidity to push forward premium higher to make value of forward dollar attractive to exporters. It is also not correct to send panic signals into market through restrictions in forex operations (by Banks and/or other stake holders) that could trigger short dollar squeeze. Rupee bulls should wish and pray for EUR/USD holding above 1.3425-1.3350 support for taking out 1.3550-1.3625 resistance window for 1.3850-1.3900 and NIFTY to hold at 4725-4675 for reversal into 5150-5200 to get the focus on rupee back into 49-52; else weak fundamental and structural dynamics would keep rupee bear trend in play into short term. As of now, we keep our fingers crossed and allow couple of days to get a clear view on the trend.
EUR/USD is boxed at 1.3425-1.3550 with no momentum to guide test/break either-way while USD/JPY found support above 76.50 for 77.30. The set sell zone of 1.3550-1.3650 and buy zone of 76.75-76.25 has held well so far and it is expected to hold for extension into 1.3350 and 77.75-78.00 where it is considered good to exit and await fresh cues. Having said this, the near/short term bias is for extended dollar strength into 1.3150-1.3000 and 79-80 to push USD Index into 80.
The strong exchange rate play pushed premium down below the strong support of 4% in 3M and 3.00% in 12M (low of 3.5% and 2.5% respectively) but bounced back strongly for close at 4.5% and 3.1% respectively. There is not enough dollar liquidity in the system for cost effective conversion of FC sources into Rupee uses. RBI’s support to infuse rupee liquidity through OMOs has cut the interest rate play on premium in the longer end; thus squeezing the 3X12M premium around 2.5%. “Operation RR” (Rupee Rescue) and resultant demand for forward dollars (from shorts squeeze and NDF arbitrage) will now push 3M premium back into 5.5-6.0% and 12M into 3.75-4.0%. Having said this, if rupee’s fall extends into new territory (driven by weak EUR/USD and NIFTY); then we get the focus back into 4% in 3M and 2.5% in 12M. For now, let us watch 3M at 4-5% and 12M at 2.90-3.40%. While the immediate bias is for move into the higher end tracking initial spot rupee gains, cannot rule out sharp reversal if rupee gets back into bear trend tracking weak EUR/USD and NIFTY. Hence, the need is to keep a close watch on EUR/USD and NIFTY. Given the lack of clarity and mixed signals, staying paid on 3X12M between 2.50-2.0% is too good to ignore both for importers and for ALM play.
Commodity market
Gold lost its steam to slice through strong support at 1710-1680 (low at 1665) but could not sustain there for back into 1680-1710. It is now important to hold above strong support at 1645-1635 to retain its bullish undertone for visit back to 1790-1810. Given the weak global cues; Gold is expected to retain its safe-haven status. Let us stay away for a while and watch consolidation at 1645-1730 and await more cues to get firm grip on directional break-out. Fleet footed traders can look to buy at 1650-1635 with stop below 1625 and look to sell at 1710-1725 with stop above 1735.
NYMEX crude failed at the set resistance/sell zone of 100-103 for push back into support/buy zone of 97-95. While two-way sideways trading mode within 95-100 will be in order at this stage; bias is for getting back into consolidation mode at 80-90 when Iran related fears (and worries) are out of the way. The strategy is to sell rally into 99-102 with tight stop for push back into 95-90.
Bond/OIS market
The market fundamentals are mixed; bearish set up triggered by tight liquidity; high interest rates and inflationary pressures (driven by weak rupee and high commodity prices) are countered by sluggish growth momentum and rate cut hopes. This brings the structural issues into play; demand-supply mismatch. The market is already in excess SLR investment mode of around 6% of NDTL with limited investment appetite for pipe-line RBI’s supplies. The demand has shifted into the shorter end of curve given the global economic woes. RBI is working its way through issuance of OMOs to bridge demand-supply mismatch. The quantum has to be huge (over Rs.1 Trillion into end of H2) to arrest spike in 1Y bond yield above 8.85% and 10Y above 9%. There would be good investor appetite (both from domestic investors and FIIs) in the shorter end on hopes of RBI getting into rate cut mode before March 2012. 1Y yield at 8.85% is not bad against 1Y OIS hedge around 8.10%. The lower 1Y forward premium below 3% provides good return on LIBOR on fully-hedged basis for foreign investors. The extension of dollar strength against major currencies will also set in to provide support to bond market. The liquidity squeeze has now shifted from dollar to rupees and will remain valid into end December 2011 and further into March 2012. Taking all these together, it would be in order to look for consolidation in 1Y bond at 8.75-8.85% and 10Y at 7.75-7.90%. Given the weak rupee and high commodity prices; headline inflation is not expected to come down in a hurry and would stay at elevated levels for extended period of time. It would be tough for RBI to address growth pressures and inflation worries at the same time. But, it is possible that priority will shift to growth on import of economic woes from the West into India. For now, let us watch two-way sideways trading mode in 1Y at 8.75-8.85% and 10Y at 7.75-7.90% with test/break either-way to attract. The strategy is to stay invested in 1Y at/above 8.85%; buy 10Y bond at 7.87-7.90% (for OMO) and sell 10Y at 7.80-7.75% (for auction).
OIS rate moves is boxed between attractive bond spread and rate cut expectations; thus providing strong support in 1Y at 8.10% (bond spread of 75 bps) and 5Y at 7.25% (bond spread of 160 bps). The resultant upward pressure is facing resistance at 8.15% and 7.35% respectively. Now, RBI’s support to rupee will push the overnight MIBOR and short term rates up; thus providing extended run into 8.20-8.25% (1Y) and 7.40-7.45% (5Y) which should hold. However, it is matter of time for shift of operative Repo rate from current 8.5% to 7.5% to push OIS rates into the short term objective at 7.90% and 7.10% respectively. For now, let us watch 1Y at 8.10-8.20% and 5Y at 7.25-7.40% with recommendation to play end-to-end with tight stop on break thereof. Strategic players can build 5Y received book at 7.40-7.45% (with stop above 7.5%) for 7.15-7.10%. It is good to get into bond swap trade in the 1Y tenor; buying bond at/above 8.85% with OIS hedge at 8.10% (as protection to possible spike in call money rate triggered by RBI’s intervention in FX market and further squeeze in liquidity on shift into second fortnight of December).
NIFTY
Having taken out strong support at 4850, NIFTY is holding above 4750 (low of 4764) for close at 4812. It would be in order to allow bit of consolidation after posting a sharp reversal from above 5350. It is difficult to get a single positive factor to look for bullish reversal in NIFTY. The domestic factors are dominated by low growth; high inflation; tight liquidity; high interest rates and weak rupee. Now, import of economic woes from the West to Emerging markets has come into play to add momentum to bearish undertone. We have miles to go for shift into stability ahead of bullish reversal. The investor appetite will be very limited for equity assets and the preference will be for short term; high yield fixed income. The exit target for first lot (on our shorts above 5350) is met at 4800 while retaining the balance with trail stop above 4950 (watch this space for t/p target). It is matter of time before we move into strong support zone of 4725-4675 but not convinced to expect strong reversal from there. Let us now watch consolidation at 4700-4900. Beyond there, an extension into 4450-4350 is on cards. The strategy is to sell correction into 4850-4925 with stop above 4950.
Moses Harding
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