MARKET PULSE - SHORT TERM UPDATE

Currency market

Rupee continues to stay in bearish undertone despite RBI’s efforts to “lead” dollar supplies and “lag” dollar demand. The efforts have not gone futile; else rupee would have already moved into 53.50-54.00. RBI has managed to remove rupee’s traction with fall in EUR/USD and NIFTY. Now, the dollar demand (from uncovered payables) is held back and “long” dollars (uncovered receivables) are being closed out. RBI rolled out measures to attract off-shore flows (from FIIs/NRIs) into sovereign/corporate bonds; but given the liquidity squeeze and fear of hard landing of global economy, foreign investor appetite is low. The upward revision in FCNR/NRE interest rates is not enough; despite the revision, it is not attractive. The way is to deregulate and allow the market to find its own mutually acceptable level. Let us await more such measures from RBI to arrest extended weakness into 54-56.

Let us now try to figure out how “low” rupee can go before reversal. The post Lehman crisis pushed rupee down by 33% (from 39.20 to 52.17) in 15 months time. Now, rupee is already down by 20% (from 43.85 to 52.73) in 4 months time, triggered by the Euro zone crisis. The present crisis is much severe compared to the financial crisis of 2008. What is different from then and now (in the Indian context) is the inflation and growth story. Indian economy then was in high growth-low inflation engine and now the reverse; hence RBI’s serious concern to limit rupee weakness and to shield its impact on inflation. So, we can safely assume that RBI will go all-out to control excessive rupee depreciation; thus diluting the risk of fall beyond 33% this time. In the given market dynamics of strong dollar (against major currencies) and weak stock market, Rupee should find its “floor” somewhere at 54-56 before reversal. The hedging strategies need to be based on this belief. The worry factor is the time to reversal. The 2008 crisis saw rupee reversal lasting for 14 months (January 2008 to March 2009). The current crisis being mix of economic; monetary and financial, the time to reversal may be long. Given the rupee liquidity squeeze, RBI will choose to turn dollar buyer to avoid infusion of liquidity through CRR cuts; thus providing kind of price stability at 51-53 till commodity prices start turning towards south.

What is short term outlook? Rupee is expected to start building its traction with (strong) USD Index and (weak) Equity market when RBI exhausts its ammunition to defend rupee. Intervention is not a solution as this will lead to spreading currency woes to money market. Given the strong downward momentum in EUR/USD and NIFTY; it is safe to assume that a strong base is set up around 51. The greenback is expected to face stiff resistance from RBI at 52.70-52.85 to stop posting a new all time low. There is high probability of this rupee support window to give way for extended rupee weakness into 53.50-53.65 ahead of shift into 54-56. It is very difficult to set a reversal point from this zone. One thing is certain; not to stay “long dollars” at 54-56 as reversal from there shall be swift. This would mean importers should cover on extended gains below 52 (into 51) while exporters stay away for 53.50-54.50. It is also clear that USD/INR has moved into a new base at 49-50 into the medium/long term. This is sharply higher from 39 (January 2008) into 44 (July 2011) and now expected to be at not lower than 49. This fits well into the set short term range of 49-54, we discussed in late October and we have already seen a sharp fall from 48.61 (31/10) to 52.73 (22/11); we would have seen end-to-end move but for RBI’s aggressive and stubborn presence. For now, while 52.70-52.85 holds; it is possible to see correction into 51.65-51.00. USD Index will face bit of resistance below 80 for pull back before getting back into the bull trend. It is advised not to chase rupee gains beyond 51.65 (into 51.00) given the complex market dynamics. There will be shorts squeeze (on run into 51.00) and may not be a bad strategy for importers to hedge part with intention to exit at 52.70/53.50/54.50. On the other hand, exporters can hedge part of receivables at 52.70/53.50 with intention to exit at 51.65/51.00. Over all, short term play is expected to stay within 51.65-52.75 with overshoot limited to 51-53.50. It is also possible that RBI provides price stability at 51.50-52.50; having sold huge quantity around 52.50, it would make sense to buy them back around 51.50 to release pressure on rupee liquidity in the system before run into tight second fortnight of December.

EUR/USD is already down from 1.42 to 1.3350 and looks set for extended weakness into 1.3150-1.3000. Over all, the play has been within the set tolerance range of 1.30-1.40 and test/break either-way was rejected straight-away. There is more bad news to come out of Euro zone to maintain firm bearish momentum on EUR/USD. Now, correction into 1.34-1.35 should hold for 1.3150-1.30 to guide consolidation within 1.30-1.35 and await fresh cues to set up directional break-out. The short term bias is however for extended weakness into 1.20-1.1850. USD/JPY is boxed between buy zone at 76.75-76.25 and sell zone at 77.50-78.00. The break-out if any will be for rally into 79.50-80.00 while 76.50 stays protected. Let us continue to play end-to-end of this range and ensure to stay “long” dollars for 79.50-80.00.

Money Market

The squeeze in rupee liquidity is up from RBI’s tolerance level of Rs.25-50K Crores to Rs.1.25 Trillion triggered by shift of dollar credit to rupee credit and fiscal slippage leading to higher market borrowing. Now, currency woes have emerged to add to pressure. If these factors remain valid for some more time, the risk is of trigger of additional LAF counter at 9.5% to drive call money rate into 10%. There will be upward push on the shorter end of the money market rate curve pushing the 3-12M curve into 10.0-10.5% by mid December.

Bond market is weak driven by inflation worries; tight liquidity and excess of supplies over demand. Banks are already holding over 6% of NDTL as excess SLR which is now being funded through Repo/CBLO counter. 1Y bond yield is in stable mode at 8.75-8.85%. There is risk of extension into 9%+ on spike in call money rate from 8.75% to 9.75%. RBI will maintain price stability in 10Y bond yield at 8.75-8.90% through balancing act between OMO and auctions. The downtrend in US Treasury yields and rally in USD will be bond supportive; thus setting up bias for move below 8.75%. Over all, Bond market is in better shape with limited price volatility. The short term outlook is mixed; weak at shorter end and steady in the longer end of the curve. Let us watch 1Y at 8.75-9.0% with bias into higher end and 10Y at 8.75-8.90% with test/break either-way difficult to sustain. The risk factor of 10Y bond yield spike over 8.90-9.0% will be on confirmation of fiscal deficit moving into 5.5% (against target of 4.6%) and additional demand for funds from the system.

OIS rates are steady at 8.10-8.20% (1Y) and 7.25-7.40% (5Y) attracting good bids at lower end driven by tight liquidity; high short term interest rates and attractive bond spread while move into higher end is attracting receiving interest on expectation of CRR and/or rate cut in Q4 if not before. Let us continue to track this range and play end-to-end. Rate cut post trigger of additional LAF counter may delay the expected move into 7.90% (1Y) and 7.10% (5Y).

Commodity market

Gold has traded end-to-end of 1680-1710 and the bias is for extension into 1650-1635 which should hold. Let us maintain our strategy to sell 1710-1725 with stop above 1735 and buy at 1650-1635 with stop below 1625. Over all, consolidation within 1630-1730 would be in order. NYMEX crude is also in consolidation mode at 95-100. Let us continue to stay with the set strategy to sell 99-102 with stop above 103 for 93-90. Over all, sideways trading within 90-100 will be in order and prepare for shift into 80-90 in due course.     

NIFTY

We are in the fourth cycle since entry into 21^st Century. The first cycle was the economic prosperity rally driving the NIFTY from 849 (low of September 2001) to high of 6357 (January 2008). The second cycle was the collapse triggered by post Lehman financial crisis to drive the market down to 2252 (by October 2008) in short span of 10 months. This was followed by a third cycle to provide relief rally to 6338 (November 2010). We are now in the fourth cycle down to 4650 in a year’s time; thus seeing 2 cycles of bull rally and now in the second cycle of bear run. The need now is to study this fourth cycle to find out the reversal point for the fifth cycle which will be third round of bull rally.

The financial crisis of 2008 resulted in fall of 65% when it was not difficult for Central Banks and Governments to bail out the financial system to protect the global economy from gloom. Now, we are in a crisis covering sovereign; economic; monetary and financial issues. The sovereign rating downgrade of the developed world has begun; none seem to fit into AAA category. The Euro zone woes have already hit the western markets exerting severe growth pressures; thus diluting the efficiency of their monetary/fiscal dynamics. The lower/mid layer of so-called group of developed countries are facing sovereign crisis. The spill-over of these woes to emerging economies cannot be wished away. China is already preparing for hard landing. India’s growth momentum is slipping from over 9% to below 7%. While other emerging economies do not have worries on inflation and currency; India is struggling to guide soft landing on headline inflation and to arrest excessive currency weakness. All these factors have lead to fall in NIFTY by 26% or so since November 2010. If a financial crisis can result in 65% fall before reversal, the present crisis can lead to much more; which is a big concern at this stage. As said many times, we have long way to prepare for reversal. The reversal cycle of 2008 lasted for just 10 months; now we are already over a year with no signs of “floor” in sight with risk of turning from bad to worse. Given this expectation, investor appetite will be low; most strategic investors have not only lost time value, there has been deep erosion in the asset value. Over all, it will be very safe to assume that we are not in good times; hence the need to allow much deeper correction from current. The next objectives for this may be around 3900 ahead of 3200. The hard landing of Indian economy is inevitable and ideally growth momentum should not go below 6.5% given the strong domestic push. Inflation should settle down around 7% or so; thus Indian economy will continue to stay with low growth-high inflation scenario for extended period of time. Let us now believe that despite the severity of the current crisis (relative to 2008), the fall should not extend beyond 50%. It would be prudent for strategic investors to stay away for extended fall into 3900-3200. Cash is king now and good to stay invested in short term; high yield fixed income assets (7-30 day Bank deposits are priced at 8.5% with upward bias and liquid funds are yielding over 9%; considered good to park monies there).

For now, it is possible that we have moved into a new range of 4350-4850 and the bias is clearly for move into the lower end. The strategy is continue to play from “short” side; buy only to book profit with intention to re-enter. Any reversal above strong 4675-4725 support zone triggered by “shorts squeeze” will be good selling opportunity with stop above 4850. Strategic players can sell in two lots at 4750-4775 and 4825-4850 with stop above 4875. It is a 100 point sacrifice trade for a reward of 400-500 points. Having run the shorts from above 5350 to 4650; it is worth it to try again.  

Will be away next week.  Next update in the second week of December.

Moses Harding