Countdown to 16th December...time to compromise and shift to balanced approach
The Indian economy is struck with all kind of woes; high inflation, low growth, high fiscal deficit, tight liquidity, high interest rates, low investor and consumer confidence etc. The external support that the domestic system enjoyed till July 2011 is down significantly; thus adding to further pressure on the economic well-being. It is not easy for RBI to manage these conflicts without prioritisation and compromise. The priority so far is to arrest upward pressure on headline inflation which was threatening to get into double-digit. RBI shifted to hawkish monetary stance to address inflationary concerns. Since March 2010, we have seen upward shift in operative policy rate from 3.25% to 8.5% and operative policy rate is maintained at the higher end of LAF corridor, the Repo rate through liquidity squeeze. It is more than 18 months into the hawkish monetary stance; but inflation is stubbornly above 9% and the growth momentum is down into 7%.
The focus has now shifted to liquidity and growth with good signs of set up of downtrend in headline inflation. The dollar liquidity squeeze (and the resultant shift of credit demand from dollar to rupees) and higher market borrowing by the Government has pushed draw down from LAF counter to above Rs.1 Trillion. The risk is also that of build up of more pressure on advance tax outflows that could trigger the additional LAF counter at 9.5%; thus pushing the call money rate into 10%. So, it is important for RBI to prevent this scenario when growth momentum is slipping below 7%. There is clear shift of priority from inflation to liquidity and it is essential to address adequacy and cost of liquidity; thus RBI is expected to reverse its hawkish monetary stance to balanced approach with agenda to maintain growth and inflation at 7.0-7.5% by March 2012.
There is already build up of expectation of CRR cut to release pressure on liquidity. RBI will also use options of OMO purchases in the bond market and USD purchases in FX market. RBI is expected to use all the three options to drive the draw down from Repo counter to below Rs.25K Crores. It is not clear at this stage on RBI’s intention to shift the operative policy rate from Repo rate to Reverse Repo rate through move into surplus system liquidity mode. This intent will push overnight rates into 7.5% without delivering rate cut. A sharp downward shift of 1% in the shorter end of the money market rate curve may not be considered prudent (and appropriate) when headline inflation stays above 9%.
There are two options with RBI now: (a) delivery of 50 bps CRR cut and maintain the drawdown from Repo counter below Rs.25K through USD purchases in FX market (to arrest sharp reversal in rupee and to build up USD reserves) and use OMO route only when bond yields are under pressure (to maintain price stability in 10Y at 8.50-8.75%) . The intent for this move will be to maintain overnight rate around 8.5% till end January 2012 when more clarity will emerge on downtrend in headline inflation. (b) delivery of 50 bps cut both in CRR and Repo rate to maintain overnight rate around 8%. This stance will be good for growth; bond and equity market but may cut the momentum of downtrend in inflation.
The better (and appropriate) option is to take one step at a time by addressing liquidity with delivery of 50 bps CRR cut. This approach will shift RBI’s priority from inflation to liquidity and stay in wait-and-watch mode before getting into pro-growth monetary actions. It will be kind of sudden reversal of stance if RBI chooses to deliver 50 bps cut both in CRR and Repo rate. Given that RBI’s main agenda is to manage inflation and liquidity; it does not make sense to expect shift of priority from inflation to growth at this stage. We expect delivery of 50 bps CRR cut while leaving policy rates unchanged.
Let us now study the impact of this expectation on the markets:
Bond/OIS market:
Bond yields are already down below 8.25% (1Y) and below 8.65% (10Y) from the peak levels of 8.85% and 8.98% respectively. The strategy to stay invested at 8.85% in 1Y and 8.90-9.0% in 10Y has worked out well but overshoot below 8.5% and 8.75% respectively was a pleasant surprise. In the meanwhile OIS rates is down from our receive zone of 8.35-8.40% (1Y) and 7.45-7.50% (5Y) and has now met the set near term objectives at 7.90% (1Y) and 7.15% (5Y). These objectives were expected to be met before 16th December based on belief that RBI will shift into softening monetary stance by then. Now that market has already moved to set script; it is time to take fresh look at the market for the next strategic actions. We need to keep in mind that markets will be illiquid during the next 3-4 weeks; hence to tighten belts for excessive volatility.
The market dynamics are mixed. While RBI’s policy stance is expected to stay supportive; supply side issues will continue to stay valid. There is no confirmation on availability of dollar liquidity (despite support from FED & Co.) to shift credit demand from rupees to dollars. It is possible that operative policy rate will be maintained at 8.5% till end January (factoring 50 bps CRR cut with no rate cut); at 8% from end January to end April (next round of 50 bps CRR cut; 50 bps rate cut and maintain operative policy rate at Repo rate) and allow shift of policy rate from Repo rate to Reverse Repo rate in Q1 FY13. It is possible that we move into LAF corridor of 7.0-8.0% by May 2012 with call money rate just above 7.0%. We may need to set our strategies based on these expectations.
There will be enough investor appetite despite Banks holding 5-6% of excess SLR in their books; thus we assume that (excessive) supply side concern is not relevant now. It is also important that we get confirmation on downtrend in inflation and growth for RBI to shift into growth supportive monetary stance. Given these expectations; the average call money rate for the next 12M is expected to be between 7.5-7.75%. Based on this assumption; we look for consolidation in 1Y bond yield at 8.0-8.25%; 10Y bond yield at 8.50-8.75%; 1Y OIS rate at 7.75-8.0% and 5Y OIS rate at 7.0-7.25%. Fleet footed traders can play end-to-end of these ranges with tight stop on break thereof. Strategic players having squared the book with good monies can look to reinstate investments by buying 1Y bond at 8.25-8.40%; 10Y bond at 8.75-8.85% and pay 5Y OIS at 7.0-6.90%.
NIFTY
There has been flood of positive news into equity market. There is comfort from external sector on extension of aggressive financial support from major Central Banks and IMF; thus diluting risks from the Euro zone. The economic data from the US is showing signs of improvement. On the domestic front, shift of monetary stance by RBI and build-up of expectations of CRR cut now and rate cuts later has pushed the bears into back foot. The resultant short squeeze has already pushed NIFTY from below 4650 above 5050 (into 5150); higher end of set near term range of 4650-5150. Having said this, it is not the time to turn bullish either. It is also time to cherry-pick stocks which has lost heavily on price multiplier in this bearish run from 6338 to 4639 since July 2011. Let us stay neutral at this stage and look for consolidation at 4850-5350. The market is expected to be volatile in thin December market; hence good opportunity for fleet footed traders to play end-to-end moves. It is also possible that FIIs shift allocation from equity to debt given the uncertainty on flow of dollar liquidity from off-shore to on-shore market; pressure on growth momentum into below 7% and lack of confidence in down trend in inflation into 7%. The shift into around 7% in growth and inflation by March 2012 could at best lead the market into consolidation mode; but the shift into positive mood would establish a strong short term base at 4750-4650 not ruling out extended gains into 5700 (high of 26th July) when we set up short term range of 5700-4700. Having moved end-to-end of this range, we may not rule out reversal back into 5700. For now, let us watch 4950-5150 with bias for extended gains into 5250-5350 while 4950-4850 stays firm. Therefore, strategy is to buy dips into 4950-4850 (with stop at 4825) with tight stop for 5250-5350. Thereafter, it would be good risk reward to sell at 5250-5350 (with stop at 5375) for pull back into 5050-5000.
Currency market
Rupee weakness held well at the set sell zone of 52.35-52.50 (low of 52.46) for reversal into 51.20. We had also suggested covering “shorts” (entered at 52.35-52.50) in three lots at 51.60-51.50; 51.35-51.25 and 51.10-51.00 in anticipation of RBI’s support to the greenback around 51. While RBI’s rupee supportive measures have yielded desired results (good pull back from 52.73 to 51.20); there has been drain over USD 10 billion in its reserves and resulted in rupee liquidity squeeze. What next? There has been bit of relief on release of dollar liquidity into the system but it may not be good enough to push forward premium higher to bring the forward market into supply driven mode. The other issues of widening trade gap and reduced flows into debt and equity markets continue to stay valid into the short term. While rupee bears are on back foot; there is no confirmation for getting into rupee bull mode, hence dollar bulls may prefer to stay light and safe. We continue to watch rupee gains to hold at 51.15-50.65 zone for reversal into 51.85-52.35. The short term outlook is for consolidation play at 51.15-51.85 with overshoot limited to 50.65-52.35. RBI has to look at options (other than CRR cut) to infuse rupees into the system. Given that it may not be prudent to resort to OMO bond purchases at current yield; the focus should shift to pump rupees through dollar purchases. There is huge build-up of pipe-line demand for dollars through ECB/FCCB payments; hence the need to build up dollar reserves when FX market gets into supply driven mode and use the same to protect rupee when it gets into trouble in due course. Therefore, it is not a good risk-reward to chase rupee gains beyond 51.15-50.65. Good signs of improvement in the US zone and uncertainty in the Euro zone should drive the USD Index above 80 in due course; thus exerting pressure on rupee, not ruling out test/break of recent low at 52.73. For now, let us watch 51.15-51.50 with overshoot limited to 51.00-51.65. Fleet footed traders can buy at 51.15-51.00 and sell at 51.50-51.65 with tight stops.
EUR/USD failed at the door of sell zone at 1.3550-1.3600 (high of 1.3548) before swift reversal into buy zone of 1.3400-1.3350 (low of 1.3361). While Euro zone continues to stay under tremendous pressure, support from all concerned would limit extended weakness to provide consolidation play in EUR/USD at 1.3150-1.3550 within short term range of 1.30-1.37. Over all, would not prefer break-out of 1.2850-1.3850 given the mixed market dynamics in play. Now, while 1.3550 holds, would prefer test/break of 1.3350 for extension to 1.3250-1.3200. USD/JPY is holding well above 77.25 but does not have the steam to take out 78.25. It would need BOJ’s action to take out huge dollar supplies for push to 79.50-80.00. Let us hold on to long dollars entered at 77.50-77.25 and add on dips into 77.25-77.00 (with stop below 76.75) for 78.75/79.75.
FX premium played perfect to the script. 12M FX premium traded end-to-end of set receive zone at 3.90-4.0% and pay zone of 3.0-2.90%. We have seen multiple end-to-end moves since July 2011. In the meanwhile 3X12M premium has moved up from the set pay zone of 2.5-2.25% to receive zone of 3.25-3.5%. What next? Now, both interest and exchange rate play will exert downward pressure on FX premium. Despite release of pressure on dollar liquidity; higher credit spread and liquidity premium will limit extended bull-run beyond 5.75-6.0% in 3M and over 4% in 12M. It is advised to receive 3M premium at 5.75-6.0% to fund FC uses through rupee sources and build 3X12M receive book at 3.50-3.65% (with stop loss above 3.75%) for pull back to 3.0-2.75%. For now, let us watch 3M at 4.75-5.75% and 12M at 3.5-4.0%; bias is in favour of move into the lower end. The risk factor to this move will be on extended rupee weakness beyond 50.65; not preferred at this stage.
Commodity market
The release of dollar liquidity pushed commodity prices higher but not having the desired momentum to get into bull phase. Gold is holding below strong resistance at 1760 while NYMEX crude is in consolidation mode at 99-102. At this stage, we cannot rule out extended gains over 1760 and 103 for gradual push into 1810 and 106.50 respectively. Given the high probability of USD Index test/break of 80, it is matter of time before reversal into 1660-1710 and 93-95. For now, let us watch sideways trading mode at 1680-1780 and 98-103; buying dips into lower end will be good risk-reward strategy for target at 1810 and 106.
Moses Harding
No comments:
Post a Comment