FED leads the way to support Global markets and to prevent global economic instability
In our research reports since August 2011, the highlight was to reflect great concerns on the dollar liquidity squeeze which triggered dollar rally across all currencies and exerted severe downward pressure on most of asset markets. During this period, EUR/USD was down from 1.4939 to 1.3144; Gold down from 1920 to 1534 and NYMEX crude down from 114.83 to 74.95. In the domestic market NIFTY was down from 6338 to 4639; rupee down from 43.85 to 52.73 and 10Y bond yield up from below 8% into 9%. It was indeed a severe blow to all asset markets and resulted in shift of financial/economic woes from external sector into India. The import content of input cost lead to inflationary pressures; shift of credit demand from dollar to rupees squeezed rupee liquidity in the system and severe downward pressure on growth momentum from over 9% to below 7%. Such is the severity of impact of dollar liquidity squeeze in the Indian economy and markets to highlight our dependence on external capital; liquidity and consumer demand.
While the stake holders were looking for concerted actions by major Central Banks to address this severe dollar liquidity squeeze; the timing (of the move from FED & Co.) and extent of financial support was a pleasant surprise. This move is considered as concerted efforts (by major economies of the World) to avert shifting of global financial crisis to economic crisis; that could lead to sovereign default/collapse. It is good to note that G7 has come together and it is possible that other members in G20 will come to the rescue act in due course to prevent spread of economic woes from developed economies to emerging economies. These efforts will limit downside risks but not expected to generate upside gains; thus shifting the market into consolidation mode till impact of these support measures kick in. It is important that global markets get out of current bearish set up soon; else authorities may not have enough ammunition to prevent things turning from bad to worse.
The lessons for the stake holders are many. But the most important (for this severe dollar liquidity squeeze) is the kind of tenor and capital leverage that was built in the system (in the developed markets) riding on the excess system liquidity wave since 2004 till 2008 US financial crisis. There was huge build up of long term assets funded by short term liabilities to enjoy the near zero liquidity premium and higher tenor spread with very low probability of spike in short term money market rates. Came the dollar liquidity squeeze and sharp fall in asset prices, financial system was struck with either junk investments and/or marketable assets which needs to be sold at deep discount. This issue continues to haunt the developed markets and has now spread to emerging economies. Now, it is important that G20 Central Banks continue to pump in liquidity to save the global economy from recession. As said in earlier report, the turnaround is distant away and not sure whether the worst is already behind us!
What is the near/short term impact on markets?
Currency market
In the previous short term update, we looked for consolidation at 51.50-52.50 with sell recommendation at 52.35-52.50 (low of 52.46) and asked importers to await pull back to cover imports in three lots at 51.60-51.50; 51.35-51.25 and 51.10-51.00. Now, USD/INR is already below 51.50 and looks set for extension into 51.00. It was not a surprise to see USD Index losing steam ahead of 80 for pull back into 78. It is possible that RBI turns into dollar buy mode around 51.00 to release rupee liquidity into the market without the need to deliver CRR cut. The belief is also that rupee around 51 looks neutral in REER terms. At this stage, let us not rule out extended “run” into 50.65-50.50 (in the absence of RBI) which is considered as strong short term base. There are lot of negative factors in store; hence not prudent to get rupee bullish and not considered good risk-reward to chase rupee gains below 51 (with reward of 50 paisa and downside risk of couple of rupees). For now, let us watch 51.15-51.65 with overshoot limited to 51.00-51.80. Exporters who sold into rupee weakness at 52.35-52.50 can look to unwind “shorts” at or below 51.00 (with stop loss below 50).
EUR/USD held well at 1.3250-1.3200 (just short of short term target at 1.3150-1.3000) but did not have steam to take out strong resistance at 1.3550-1.3600 despite FED’s aggressive move. Now, it is possible that EUR/USD gets into consolidation mode at 1.3350-1.3850 before reversal into 1.3150-1.3000 ahead of 1.2850. There is not much of hope on the Euro zone to look for sustainable rally in EUR/USD. For now, the strategy is to sell at 1.3550-1.3600 (with stop above 1.3625); if stopped the rally should stay below 1.3750-1.3850 before reversal into 1.3450-1.3350. As counter trade, it is good to buy dips into 1.3425-1.3350 (with stop below 1.3325).
USD/JPY is in sideways trading mode at 77.25-78.25. Now that BOJ is extending its support to Euro zone; it would be the right time to address its currency problem. It is matter of time before we see USD/JPY back above 80. For this move, USD at 77.25-76.75 will look attractive (and cheap) to acquire.
The 3X12 strategy in FX premium to pay at 2.5-2.25% has proved good as the reversal above 3% from below 2.5% has been swift. In the meanwhile, 3M premium is up from below 4.5% to above 5% and 12M sharply up from below 3% to above 3.5%. Let us now watch 3M at 4.5-5.5% and 12M at 3.25-4.0%. The bias is for move into upper end and would not prefer test/break thereof. Over all, 12M has nicely moved from our receive zone of 3.90-4.0% into the pay zone of 3.0-2.90% and now in preparation of move into 3.90-4.0%. Let us unwind 3X12M paid book at 3.25-3.5%.
Bond/OIS market
What a move in the bond market? We advised strategic investors to stay invested in 1Y bond at 8.80-8.90% and 10Y bond at 8.90-9.0% in anticipation of RBI’s shift of focus from inflation to liquidity and growth. The speed of reversal was indeed a surprise as 1Y bond yield is now down at 8.25% (from high of 8.85%) and 10Y bond at 8.70% (from high of close to 9%). The par curve in the 1-10Y tenor was seen unsustainable and now spread of 40-50 bps looks decent. What next? There has been bit of relief on inflation with establishment of downtrend into 7.5-7.0% by March 2012. RBI’s focus will now shift to address the system liquidity squeeze for move into its tolerance level of maximum 1% of NDTL (25-40K Crores from over Rs.1 Trillion) and to arrest slippage in growth momentum below 7%. It is matter of time before we see shift of operative policy rate from above 8.5% to 7.5%. It is possible through aggressive injection of liquidity (without rate cut) or 1% rate cut (maintaining operative policy rate at Repo rate) or mix of both. It would be good to maintain overnight rate around 7.5% to maintain growth momentum and headline inflation around 7%. There is no strong case at this stage to look for call money rate move below 7.5% to maintain 1Y return above headline inflation. Given this expectation into the short term, 1Y bond yield is expected to find support around 8% (40-50 bps tenor spread over the overnight rate) and 10Y bond yield around 8.5% (80-100 bps tenor spread). So, it is prudent to exit “longs” at 8.10-8.0% (1Y) and 8.60-8.50% (10Y). The negative factors concerning the markets continue to stay valid. The pressure on fiscal deficit and higher demand on the market (additional bond supplies from RBI) will limit gains. We cannot rule out unwinding of recent gains (1Y back into 8.75% and 10Y back into 9.0%) on trigger of negative news from the external sector or possible rating watch on India driven by low growth; high inflation and high fiscal deficit. Let us now watch 1Y at 8.15-8.40% and 10Y at 8.60-8.75% with test/break either-way not expected to sustain.
OIS rates moved to the script inching towards the set near term objectives at 7.90% (1Y) and 7.10% (5Y). Let us prefer to unwind “received book” entered at 8.30-8.40% (1Y) and 7.40-7.50% (5Y) and await fresh cues beyond there. While it is possible that 1Y OIS rate slips below 7.90% (into 7.75%), probability of 5Y move below 7.15-7.10% is very low at this stage. It would need sharp rally in bond market with 5-10Y yield below 8.5% to drive 5Y OIS rate below 7%. Let us not prefer this move now. Hence, let us watch 7.85-8.10% (1Y) and 7.15-7.35% (5Y); test/break either-way to attract.
Commodity market
FED move provided the momentum for Gold to take out the strong resistance at 1710 but lacks steam for extended run above 1760. NYMEX crude has also rallied from support zone of 97-95 into resistance zone of 101-103. Now, it is possible that Gold extend its bull run into 1790-1810 which is expected to hold to provide near term consolidation at 1710-1810. In the meanwhile, NYMEX crude is expected to trade in sideways mode within 95-103. The strategy is to play end-to-end move with tight stop on break thereof.
NIFTY
The reversal from resistance window at 4850-4875 found good support at 4725-4675; but FED lead rally above 5000 lost steam for close at 4937. Now, the downward momentum from external sector has shifted to neutral mode while domestic factors continue to weigh heavily on the market. The worries from low growth; high inflation; high fiscal deficit; tight liquidity and high interest rates would continue to keep the investor appetite low into the near/short term. While it is possible that NIFTY has posted a near/short term low at 4639 but extended rally above 5150 is not seen to be on cards. Hence, we shift our near term focus into 4650-5150. While strategic investors wait to buy one-third of appetite at 4700-4650; fleet footed traders to play end-to-end with tight stop on break thereof. For now, we look to sell in two lots at 5000-5025 and 5125-5150 with stop above 5175 for 4725-4650.
Moses Harding
No comments:
Post a Comment