MARKET PULSE - 13 DEC 2011

Currency market

The reversal from 51.18 to 52.85 was swift and it took just 5 trading days. The speed of reversal despite sporadic dollar supplies from RBI would be the biggest worry for RBI and the Government. This is not good for the economy when the system is struggling with high inflation and slippage in fiscal deficit. The fundamentals for rupee are very weak. The domestic cues are bearish and external sector is yet to see the worst. The immediate support for rupee is at 53.35-53.50; further ahead is 53.90-54.00. Given the downward pressure on EUR/USD and NIFTY, test of these support levels is certain. Need to watch the momentum on the reversal from these historic lows. For now, let us watch 52.75-53.75 with overshoot limited to 52.50-54.00.

EUR/USD having traded multiple times within 1.3250-1.3450 and as expected has shifted into lower range play at 1.31-1.33 with risk of extended weakness into 1.30-1.2850. USD/JPY is now boxed at 77.50-78.00 and there are no factors to indicate test/break of 77.00-78.25; however bias is for extended dollar gains into 79.25-79.50 into the near term.

FX premium was driven lower by mix of both interest and exchange rate play. The reversal from peak of 6% (3M); 4.5% (12M) and 4% (3X12M) is sharp for close at 5.6%; 4.15% and 3.6% respectively. The immediate term bias is for gradual move into 5.0% (3M); 3.75% (12M) and 3.25% (3X12M) which is expected to hold. For now, let us watch 5.25-5.75% (3M) and 3.90-4.35% (12M); while the bias is for move into lower end, test/break thereof is expected to attract.

Bond/OIS market

The strategy to buy into weakness proved good as initial weakness in 10Y Bond was supported at the door step of the set buy zone at 8.55-8.60% for rally into 8.43% before close at 8.45%. In the meanwhile OIS rates too eased from days’ highs for close at 7.79% (1Y) and 7.04% (5Y). Now, weak IIP data has set the road clear for extended bond rally irrespective of RBI actions on 16^th December; pipe-line bond supplies and slippage in fiscal deficit. The shift into monetary easing cycle is just round the corner. While all asset classes will be under pressure; investor interest will shift into bond market. For now, let us watch 8.35-8.50% (10Y bond); 7.70-7.85% (1Y OIS) and 6.95-7.10% (5Y OIS). The bias will be for move into lower end while weakness into upper end will attract. The high growth/high inflation market dynamics pushed operative policy rate from 3.25% to 8.5% since March 2010. Now, shift into moderate growth/moderate inflation dynamics (both meeting around 7% on or before March 2012) should establish downtrend in operative policy rate to 7.0% by March 2012. The shift into this scenario would need 1-2% of CRR cut and 0.5-1.0% rate cut. So, need to stay invested for this move with 1Y target at 8.0-7.75% and 10Y at 8.0-8.25%. This will drive 1Y OIS rate into 7.60-7.50% and 5Y OIS into 6.90-6.85%. Beyond there, it would need shift into low growth (below 6.5%) and low inflation (below 6%) scenario to drive the operative policy rate below 7%. Let us review this when RBI reverses into monetary policy easing stance.

Commodity market

The downtrend has picked up momentum as Gold eased from 1714 into the set objective of 1675-1665 (low of 1657). The downward momentum is now strong; thus setting up for extended weakness into 1620-1605 while 1680 holds firm. In the meanwhile, NYMEX crude failed ahead of 100 for reversal below 98 and in course for extended weakness into 95 while reversal into 100 is difficult to sustain.

NIFTY

The weak domestic fundamentals with combination of low growth and high fiscal deficit continue to keep the bears in play. The reversal from 5100 to 4750 was swift; underlying the strong bear grip on the market. Now, sharp decline in rupee is also a worry which could trigger FII pull out ahead of year end. The next strong support of 4650-4625 is just striking distance away and market is set to complete end-to-end move within the set near term range of 4650-5150. Now, quick shift into easing monetary cycle by RBI will help to limit weakness but may not be good enough to provide sustainable rally into near/short term. Now, we focus our attention for consolidation at 4650-4850 not ruling out test/break of recent low at 4639. Let us not get the focus away for extended weakness into 4350-4250; considered good for strategic investors to lock into one-third of investment appetite.

Moses Harding