Euro zone crisis....there is “will” but ways and means seems “tough to execute”
As leaders in the Euro zone continue to be in deliberation mode to bring out solutions to restore financial stability and investor confidence; Global rating agencies are gearing to effect downgrade on most (if not all) of Euro zone countries. It is good to note that all major powers (of G20) have extended support to France and Germany; it may not be for love of the Euro zone but to prevent spread of economic woes from Euro zone to rest of the world. It is important to prevent hard landing of global economy; the damage could turn the economic clock back by couple of decades! The people of the Euro zone have to make lot of sacrifice (and compromise) in the short/medium term for their long term benefits. While Central Banks are geared to extend financial support; the focus is now on Government’s prudent fiscal management. The long term survival of the Euro zone depends on effective implementation of fiscal prudence; sharp cuts in fiscal deficit and to make both ends meet without compromise on social support/obligations. It is obvious that it is not going to be easy when economic system gets into sub-optimal capacity; pressure on revenue collections; low consumption; high unemployment; high input (and interest) cost; higher financial burden on social security etc. The execution plans have to be supported (and endorsed) by the people of the Euro zone who should be prepared to take short term pains for long term gains (and survival). It will be tough for the Euro Zone Governments to make their citizens understand this reality and to get their support in this tough journey!
Given this scenario, the asset markets will not get into bullish mode in a hurry. It is time for consolidation (with marginal downward bias) into short/medium term. If all goes well by then, there will be strong build-up of momentum for a bull rally thereafter. The consolidation phase will be long; may be another 2-3 years from now. This will be one of the longest bear phase which began in 2008. The global economic system will be in low growth; low inflation and soft interest rate mode till confirmation of reversal into recovery. The system needs to be in adequate liquidity mode till then. India is bit unique in this space with moderate growth; high inflation and high interest rates. This scenario may not last long as growth pressures will be felt; inflation will trend down sharply and interest rate will turn south. It is time for the Indian Government to take lessons from these issues and set course-corrective actions. The major (and critical) issues revolve around growth and exchange rate. India needs external capital; liquidity and consumer demand to maintain 9-10% GDP growth; else need to live with 6-7% growth momentum. Exchange rate stability would require sustainable capital account flows (without risk of reverse flow) given the huge gap in the trade/current account. The need is to bridge the trade gap and to pull long-term capital flows delinking the dependence on hot money inflows. It would need roll-out of 2G (second generation) economic reforms. The roll-back of retail FDI says it all....we need political consensus on this critical agenda and Government should work on this to insulate Indian economy from external shocks.
Currency market
The reversal in USD/INR Spot from 52.73 held at 51.20; trading end-to-end of set short term range play at 51-53. Now, it is important that the market gets into consolidation mode at 51.15-51.75; test/break of 51.75 will quickly trigger revisit to the historic low of 52.73. The market dynamics are not in favour of test/break of 51.15 into 50.65 at this stage. This is an important factor that importers should keep in mind; not to chase rupee gains into 51.15-50.65. Exporters can afford to stay with patience for immediate weakness into 51.65-51.75 to cover up to 1M receivables and into 52.65-52.75 to cover 3-6M receivables. For this run; USD Index will hold above 78.20 for rally into 79.85-80.00, not ruling out further extension into 81 or so. For now, let us watch sideways trading mode at 51.25-51.65 with overshoot limited to 51.15-51.75. Trade recommendation for traders is to buy at 51.25-51.15 and to sell at 51.65-51.75 with tight stop. Strategic players who have exited “shorts” entered at 52.35-52.50 on reversal into 51.35-51.20 can look to buy dips in two lots at 51.35-51.25 and 51.10-51.00 (with stop below 50.90) for 52.65-52.75.
EUR/USD is boxed at 1.3350-1.3550; end-to-end moves providing good opportunity for fleet footed traders. The market will continue to stay in consolidation mode till emergence of clarity in Euro Zone. However, threat from sovereign downgrade will keep EUR/USD in downtrend into 1.3150/1.30/1.2850; thus any reversal into 1.3450/1.3550/1.3650 will be considered good to short the currency pair for 100-300 pips.
USD/JPY is holding well at 77.75-77.50 support zone but would need push from BOJ to crack the 78.25-78.50 resistance zone for extended run into 79.50-80.00.
FX Premium stayed bid despite strong downward momentum from both exchange and interest rate play. This move has triggered the 3X12M trading strategy to receive at 3.5-3.65% (Feb/Nov at 137-143). Now, 3M at 5.5-5.75% and 12M at 4.0-4.25% will generate good interest. Strategic players who paid 12M from 3.5-2.90% to convert FC sources into rupee uses can look to reverse position; double benefit from drop in rupee yields and spike in FX premium. It is also good to fund PCFC book through rupee sources absorbing spike in 3M premium at 5.5-5.75%. Now, we will watch 3M at 5.0-5.75% and 12M at 3.5-4.25%; spike into higher end is not expected to sustain for sharp reversal into lower end. The sharp spike in liquidity/credit premium for dollars and reversal in domestic money market rates will cut the bullish mode above the set higher end. The downward momentum will be from release of FII hedging interest on recent investment allocations.
Bond/OIS market
The draw down from Repo counter at over Rs.1 Trillion (with risk of further liquidity pressure on run into advance tax outflows at start of next reporting fortnight) and resultant expectation of CRR cut and OMO purchases continue to keep the bond market in bullish undertone. While 1Y sovereign yield is steady around 8.20-8.25%; 10Y yield has slipped from over 8.65% into 8.58% into striking distance of the lower end of set near term range of 8.50-8.75%. The system is already in excess investment mode to the tune of 5-6% of NDTL with pipe-line supplies of 1.5-2% of NDTL for rest of FY12. Given this scenario, RBI is expected to continue with OMO operations till completion of Government borrowing schedule. It is also possible that downtrend in inflation and growth will be sighted soon; to get into interest rate cut mode before end of FY12. All these expectations will keep the bond market in bullish mode. RBI may need to fall in line with rest of the Central Banks of the World in monetary actions to arrest growth pressures; therefore, rate cuts and shift of operative policy rate into lower end of LAF corridor is just matter of time. It is important to stay invested for this move. Now, any reversal in 1Y yield into 8.25-8.40% and 10Y yield into 8.65-8.75% will attract investors for March 2012 target at 7.5% and 8.0% respectively.
OIS rates in consolidation mode at 7.90-7.95% (1Y) and 7.15-7.20% (5Y) on unwinding of received book. The reversal from recent high of 8.40% (1Y) and 7.50% (5Y) is sharp; hence it is not abnormal to see some good bids at current levels. It is matter of time before we hit the next objectives at 7.75% in 1Y and 7.0% in 5Y. We also need to stay prepared for spread squeeze in the 1X5 on shift of operative policy rate from higher end to lower end of LAF corridor. Till then, it is prudent to trade from “received” side by receiving 1Y at 7.95-8.0% and 5Y at 7.20-7.25% with tight stop. The range to watch for now will be 7.75-8.0% in 1Y and 7.0-7.25% in 5Y.
Commodity market
The rally in Gold halted at the door of the set resistance at 1760 for reversal into immediate support at 1710 (which was a stubborn resistance earlier). The signals are mixed here but there is marginal risk of extended correction into 1680-1665. Over all, sideways trading mode at 1660-1760 will be in order.
NYMEX crude is boxed at 100-102 and is expected to stay in consolidation mode at 98-103 into the near term. Over all, the chance of reversal into 93-90 is high while any bull run should find it difficult to extend beyond 106. Strategic players can look to sell in two lots at 102-103 and 105-106 (with stop at 107) for 95/93/90.
NIFTY
NIFTY was in tight consolidation mode at 5000-5050. There are more of negative factors in play both from domestic and external sectors; hence it is very difficult to get into bullish mode at this stage. It should also be noted that reversal from 4650 into 5050 was driven by shorts squeeze and not genuine investments into the short/medium term. The bears are in pavilion right now to get clarity on developments in the Euro zone; sovereign downgrade of Euro zone countries; monetary actions from RBI etc. Given these market dynamics, the best scenario seems to be consolidation at 4650-5150. The market has already discounted RBI’s monetary actions (CRR cut now and rate cut later) and confirmation of downtrend in growth momentum into 7.0-6.5% will bring the bears into bat. For now, let us watch consolidation at 4950-5150; not ruling out test/break of 5150. But, the rally should not extend beyond 5200-5300. Strategic players can look to sell in two lots at 5150-5200 and 5275-5325 (with stop above 5350) for reversal into 4950-4850. As counter trade, it is good to buy dips at 4950-4850 (with stop at 4825) for 5150-5200.
Moses Harding
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