Stage set for reversal into soft monetary stance
There is now confirmation from the Government on slippage in fiscal deficit; downtrend in growth momentum and widening trade deficit not being met with adequate capital account flows. There is good possibility of shift of focus (away from inflation) to address issues on growth and exchange rate, which we highlighted as major risks to the economy into short/medium term. While addressing these most critical issues; it is important to keep the system liquidity in adequate mode (if not in over-hang mode) and establish downtrend in interest rates. The moderation in supply side issues and release of demand-push factors will drive inflation down into the short term. Having addressed inflationary concerns for over 18 months since March 2010; it is time to address issues to prevent hard landing of the Indian economy. There is confirmation from RBI as well indicating the need to maintain system liquidity at plus/minus 1% of NDTL. The system will now be short by 2-3% (on shift into new reporting fortnight starting 17th December) despite OMO purchases in bond market; it is time to release liquidity through CRR cut as RBI may need to stay in USD sell mode in FX market to arrest pressure on rupee.
The slippage in fiscal deficit into 5.5% of GDP is much higher than the set target of 4.6%. While there are issues in forecast; the severe impact from the Euro zone crisis was not probably envisaged properly. The disinvestment plans could not be executed on depressed market conditions; higher commodity prices resulted in overshoot of subsidy and cost escalation was not bridged through higher revenue. Now, the demand (of the Government) from the market will shoot up sharply for rest of FY12 and into FY13. RBI would need to release rupee liquidity into the system while working on strategies to “pull” off-shore liquidity into the domestic system. The demand for rupee credit has risen sharply since July 2011 and flow of foreign currency liquidity (into Indian debt and equity markets) will remain subdued despite aggressive liquidity injection into the Euro zone. We have witnessed uptrend in operative policy rate from 3.25% to 8.5% during March 2010 to October 2011 and the stage is now being set for reversal into the lower end. The process will be a long haul into mid 2013. This reversal action (to prevent hard landing) is not good news for the economy; equity and currency market will be under pressure while bond market gets into bullish mode. The strategy (since August 2011) to move investments from equity to bond market will prove good (and profitable) during this period.
Currency market
The reversal from 52.73 halted at 51.20; thus completing end-to-end move within the set near term range of 51-53. The reversal from 51.20 to 51.90 met with dollar supplies from RBI but close above 51.75 is bearish. The reversal from 51.20 to 51.90 was swift; hence it was in order to get RBI’s attention. However, it is important that USD/INR post weekly close below 51.75-51.65 to delay extended weakness into 52.35-52.50 ahead of knock at the all time low. The mood is bearish and shift into soft interest regime (with adequate system liquidity) will add to pressure. The forward segment is expected to stay in (dollar) demand driven mode and flows into capital account will not be adequate to bridge the trade gap. RBI’s ability to support rupee is also limited at this stage although it would do its best to cushion excessive one-way move. Over all, there is nothing to cheer up the rupee bulls and limited rupee bullish signals ahead would keep them in defensive mode for extended period of time. Having said these, it is good for exporters to cover 1-3M payables on weakness into 52.00-52.10; 52.35-52.45 and 52.70-52.80. Importers may need to stay cautious and it is prudent to stay mostly hedged on reversal into 51.65-51.50 and 51.35-51.20. There are no factors at this stage to trigger revisit below 51. For now, let us keep our focus at 51.50-52.00 with bias for extension into 52.35-52.50. Hold on to “long dollars” entered at 51.35 (with stop below 51.50) for 52.00/52.15.
EUR/USD traded end-to-end of 1.3450-1.3250 and expected to stay in sideways trading mode within this range till today’s EU summit is out of the way. The end-to-end moves within this familiar range was great treat to fleet footed traders. As of now, there is no confirmation of extended weakness below 1.3250-1.3150 zone into 1.30-1.2850. We may need to allow reversal from 1.3250-1.3150 into 1.3550-1.3650 before sharp move into the set short term objective at 1.30-1.2850. It is important for Euro zone authorities to avoid sending negative signals into the market. The need is to roll-out concrete plans rather than providing simple solutions. A tough and aggressive monetary and fiscal stance is the need to save the Euro zone from collapse or disintegration. With the hope of rally in EUR/USD post EU summit; let us continue to stay with the set near term range of 1.3150-1.3650 and any disappointments thereafter will shift the range into 1.2850-1.3150; not ruling out a gradual and extended weakness into 1.20-1.18 thereafter.
USD/JPY continues to struggle at 78.00-78.25 resistance zone. More the delay in taking out this resistance, there is high probability of extended weakness below 77.25. While we continue to watch consolidation at 77.25-78.25; let us stay neutral on the break-out direction. The bias is marginally in favour of move into 79.50-80.00 in due course while 76.75 holds firm; hence need to stay “long” for this move.
The reversal in 12M FX Premium from 4.25% found support at 4.0-3.90% (the earlier resistance) despite strong downward momentum from interest and exchange rate play. It is driven by multiple factors such as dollar demand from importers; FII interest to freeze interest arbitrage on their investments in sovereign/corporate debt market and improvement in availability of dollar liquidity post supportive measures in the Euro zone. In the meanwhile 3M premium found support at 5.25% for extension into 5.75-6.0% on higher demand for dollars in the shorter end. The up move in 3X12M held at 3.75% for consolidation play around 3.5%. What next? The factors are clearly mixed. CRR and rate cut expectations into the short term should prevent us initiating “paid book”. Trading from “received side” will be painful paying higher cash/tom carry cost; hence it is safe to trade 3X12M. Having chased 3X12M from 2.5-2.25% to 3.5-3.75%; it would make sense to switch side to build receive book on 3X12M on overshoot above 3.75% (Feb/Nov at 148). For now (on run up to monetary policy), let us watch 3M at 5.25-6.0% and 12M at 3.90-4.35%. The recommendation is to receive 3M at 5.75-6.0% (for ALM play) to fund PCFC through rupee resources and receive 3X12M above 3.75% (for pull back into 3.25-3.5%). Fleet footed traders can receive S/Nov at 211.50-216.50 (with stop at 224) for profit target at 199-194).
Bond/OIS market
The bull-run continued to drive the 10Y yield down from 9% to 8.50% while 1Y bond yield is down from 8.85% to 8.25%. Such is the force behind the OMO operations and expectations for CRR cut now followed by rate cut soon thereafter. So, it is important for RBI not to disappoint the market with the need to address overshoot in fiscal deficit and growth pressures. Now, let us allow consolidation in 10Y bond yield around 8.50% on run up to monetary policy. The delivery of 50 bps CRR cut will provide price stability at 8.35-8.50%. The guidance on the way forward (on the timing of rate cut action) will be watched to trigger the next move into 8.25% or 8.65%. In any case, market is expected to set up short term range play at 8.25-8.65% post monetary policy. It may not be prudent at this stage to chase extended gains given the huge bond supplies from RBI. OMO has to be aggressive to bridge demand-supply gap and there has to be clear signal of shift into rate cut mode to keep investor appetite intact. These are the risk factors now to guide weakness into 8.60-8.75% which is considered good for strategic players. For now, let us watch 10Y bond at 8.45-8.60% and it is prudent to exit “longs” on test/break of lower end and to stay “light” on run up to monetary policy. RBI doing nothing on 16th December will drive the yield back into 8.60-8.65% and delivery of CRR cut may not result in extension of gains beyond 8.35%; hence the advise to stay square or light ahead of RBI’s stance on 16th December.
OIS rates nicely eased below 7.80% (1Y) and 7.05% (5Y) and just a step away from the set near target of 7.75% and 7.0% respectively. Here again, let us not chase gains beyond 7.80-7.75% (1Y) and 7.05-7.0% (5Y). Let us unwind “received book” here and stay square for now. It is possible that we would get a bounce back into 7.95-8.0% (1Y) and 7.15-7.20% (5Y) to reinstate. Let us watch tight consolidation at 7.75-7.90% (1Y) and 7.0-7.15% (5Y) on run up to monetary policy. At this stage, gains below the lower end will be considered as excessive; hence good to initiate paid book. Having chased the 5Y rate from 6.70% to 7.50% and back to 7.0%; let us look to initiate paid book in 5Y OIS at 7.0-6.90% (with stop loss below 6.85%). Given the expectation of growth and inflation meeting around 7% in the short term; initiating paid book below 7% is considered as a low risk-high reward trade. It is also time to absorb the “discount” for the time value in 1X5 tenor and bond spread of 135-150 bps (in expectation of spread squeeze on shift of operative policy rate from Repo rate to Reverse Repo rate).
Commodity market
Gold did not have the steam to take out 1760 (high of 1754) and reversal from there was sharp to take out 1710 (low of 1704) but follow-through momentum thereafter is not seen. However, it is matter of time for extension into 1680-1665 driven by dollar strength and complexities in the Euro zone. Let us continue to stay with the set near term range of 1660-1760 with test/break either-way not expected to sustain.
NYMEX crude lost steam at 101-102 for reversal into 98 to trade end-to-end of set near term range of 98-103. Here again, the directional bias is mixed. However, bull-run should find stiff resistance at 103-106 for reversal into 95-93. Hold on to shorts entered at 101-102 (with stop above 103) for 95-93.
NIFTY
The confirmation of growth pressures and slippage in fiscal deficit drove the NIFTY down from close to higher end of set near term range of 4650-5150 (high of 5100) and close below 4950 is bearish. As of now, while all factors (both from domestic and external sectors) are negative, expectation of shift of monetary stance (from neutral to soft) will limit weakness. Let us continue to watch this range and it is not preferred to chase test/break thereof. For now, let us watch consolidation at 4850-5000 with bias for extension into 4700-4650 which is expected to hold. NIFTY has already priced in RBI’s CRR cut (and signals for rate cut soon thereafter); any disappointment there will put 4650 to risk (to get the focus back to 4350-4250).
Moses Harding
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