Market Pulse – Short term update (Next update in second week of January 2012)
Breaking News: RBI deregulates NRE/NRO rates (FCNR in pipe-line???)
RBI’s extra-ordinary act of imposing strictures in FX operations did not yield desired results. Despite use of the most stringent measures, RBI had to supply dollars to arrest rupee weakness above 53 to guide stability around 52.50; thus the need to trigger the next shot. The move to deregulate NRI rates was expected since deregulation of domestic SB rate. While the impact from blue and white collared NRIs is minimal; significant flows can be pulled in from high net worth NRIs. In the regulated regime, the interest rate for FCNR/NRE deposits was much lower than what high net worth NRIs could get in the off-shore market without dilution in credit/counter-party risk. Now, it is level playing field for Indian banks to compete with off-shore banks. It is estimated that HNI NRIs park major portion of their investments in the off-shore market and it is time to attract when financial system in the developed economies are in downgrade mode.
What is the impact on inflows? Now, there will be interest arbitrage opportunities for NRIs with capability to raise funds abroad at lower cost. NRE rates are expected to be priced at 9.25-9.75% for 1Y tenor; 8.75-9.25% for 3Y tenor and 8.25-8.75% for 5Y tenor. These rates are in line with high value domestic rupee deposit rates. Banks are also expected to have differential rates for low and high value deposits. It would make good investment sense for NRIs to look at 3-5Y tenor NRE Rupee deposits at spot rupee value of over 53. Rupee is not expected to stay weak at 53-56 into the long term. The expectation is for rupee stability around 49-52 in the next 3-5 years. Given the repatriation facility for NRE deposits; rupee stability in 3-5Y time period provides attractive dollar return on NRE rupee deposits to earn higher interest rate with minimal risk on adverse exchange rate impact. This should help bridge the demand-supply gap till FDI issues are resolved. India needs to bridge the current account gap through long term NRI/FDI flows to reduce dependence on hot money flows and to arrest excessive rupee weakness.
What is the impact on currency? The main issue for RBI is to bridge the demand-supply gap to make its intervention effective. To this purpose, RBI has done enough to “cut” the demand and “open up” supplies. With these measures, rupee should stay steady around 52 (within 51-53). Else, RBI may need to remove “cap” on off-shore borrowing limit for Banks. This will open up flow of additional dollar liquidity through foreign banks and foreign branches of Indian banks. This will also help in release of pressure on rupee liquidity. Now that dollar demand from genuine export cancellation and corporate/interbank speculation is taken out; rupee should get back into stability when demand from genuine import hedge is out of the way. Having said these, dollar strength in the near/short term against major currencies (EUR/USD into 1.20) and weak stock market (NIFTY into 4250) are risk factors to this expectation. But, importers need to take comfort from RBI’s strong intention to protect rupee weakness beyond 53-54. RBI is expected to protect this level till headline inflation dips below 7%.
Currency market
Let us look for stability in spot rupee at 52-53 with bias for move into 51. At this stage, we can safely assume that RBI will protect excessive weakness beyond 53 and run-away gains below 51. Rupee having moved to its fair value; it is important to prevent getting back into over valuation to retain export competitiveness. This is essential to address widening gap in the trade account. Given the current market dynamics, strategy for exporters is to cover 6-12M receivables on spot weakness into 52.75-53.25 while importers stay away for move into 52-51 to cover up to 6M payables. It is good for companies to shift rupee liabilities into US Dollar for 3-5/10Y tenor for good interest “carry” with minimal risk of depreciation on the underlying asset net of carry earned. In the near term (for next three weeks); let us prefer consolidation at 51.75-52.75 with overshoot limited to 51.50-53.00.
EUR/USD has held well at 1.3000-1.2950 support but losing momentum on correction into 1.3050-1.3100. The end-to-end move within the set 1.2850-1.4150 is met and preference into the near term (for next three weeks) is for consolidation at 1.2750-1.3250. It would need strong positive news from the Euro zone to get the investors into risk-off mode to shift the appetite for non-dollar currencies. Strategy is to play end-to-end moves with tight stop on break thereof. USD/JPY is in consolidation mode at 77.50-78.25 for long time now since break out of earlier resistance at 77.25. The bias is for shift into higher base for near term consolidation at 78.25-79.25. Strategy is to stay “long” dollars with stop below 77.25 for 79.25-79.50.
We had set up near term range play at 6.5-7.5% in 3M and 4.5-5.5% in 12M and looked for test/break of lower end not to sustain but to pick up momentum for move into higher end. This expectation was based on strong upward momentum from exchange rate play tracking lower USD/INR and release of dollar liquidity squeeze in the system. The interest rate play provides decent support given RBI’s serious concern on inflation. The reverse from below the set lower end for close at 6.8% (3M) and 4.8% (12M) was swift. Let us now look for consolidation at 6.5-7.0% in 3M and 4.5-5.0% in 12M. The bias will be into higher end tracking stability in spot rupee at 51.50-52.50. Let us not chase rally beyond the higher end at this stage.
Fixed Income/Bond/OIS market
The draw down from Repo counter touched Rs.1.5 Trillion (around 2.5% of NDTL); call money rate hit 9.5% and 3M money market rate into 10.00-10.25%. The timing of meeting these set objectives was perfect triggered by advance tax outflows on shift into new reporting fortnight. The tight liquidity is there to stay into the first week of new reporting fortnight starting 17th December. We need to see how RBI would be able to bring the system shortfall into its comfort level of minus 1% of NDTL. RBI chose to avoid injecting liquidity through CRR cut considering this as start of monetary reversal cycle. RBI continues to stay in USD sell mode in the FX market. It has to be seen how RBI is able to release liquidity pressure with use of only OMO operations without triggering excessive rally in the Bond market.
Bond market derived comfort from RBI’s preference of OMO operations. RBI expressed concerns on growth and inflation but the bias has shifted clearly towards growth pressures. It was not a surprise to see post policy rally in 10Y bond into 8.37%. Over all, the strategy to stay invested on weakness into 8.50-8.55% has worked well as rupee driven weakness in bond market was supported around 8.51%. Now that rate cut action is distant away (April to June 2012), it is not fair to expect extended rally in 10Y bond yield beyond 8.35-8.25% despite OMO purchases. The bond supplies from RBI will stay at elevated levels through rest of the FY12. So, consolidation at 8.35-8.45% (within 8.25-8.50%) would be in order. Strategy is to play end-to-end of this range. Strategic investors can stay invested at 8.45-8.50% for June 2012 target at 8.10-8.0%.
OIS market has nicely traded end-to-end of 7.70-7.85% in 1Y and 6.90-7.15% in 5Y during pre and post policy period for close at 7.72% and 6.92% respectively. While RBI has shifted its bias towards growth; its concerns on inflation continues to remain valid. So, it is not clear whether test/break of lower end of this range will sustain. The risk-reward for staying “received” at current levels is not attractive. The option therefore is to either stay square or stay light by absorbing extension below 7.70% in 1Y and 6.90% in 5Y for pull back to 7.85% and 7.05-7.15% in 5Y.
Commodity market
Gold has traded end-to-end of technical support at 1560 and resistance at 1600. Having reversed quickly from 1754 (high of 8/12), it is in order to lose momentum on move into 1560 triggering short squeeze. Now that USD has got into stable mode, we may need to allow for consolidation at 1560-1620 with bias for test/break of lower end into 1500 in due course.
NYMEX crude has come off nicely from resistance zone of 100-103 (high of 101.25) into support zone of 93-90 (low of 92.5). The downtrend is firmly in place for test/break of 90 for move into 85-80 in the near/short term. For now, let us watch consolidation at 90-95 with overshoot limited to 87-98.
NIFTY
NIFTY has nicely traded end-to-end of set near term range of 4650-5150 for gradual reversal from 5100 to 4628 before close at 4651. The trend since August 2011 remains unchanged. The investor preference is for fixed income assets as market continue to stay in risk-off mode. All asset classes (except bond market) are in down trend since then. Now, the near term range stands revised to 4350-4850 not ruling out extension into 4250. Strategy is to sell at 4750-4850 for gradual move into 4350-4250. Time is not yet right to trade from “long” mode; need to buy only to square shorts for profit booking. Strategic investors can afford to buy one-third of the appetite at 4350-4250 and track fresh cues thereafter.
Moses Harding
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