Rupee bulls trigger expectation of rate cut on 24th January.....
The market is divided on RBI’s policy stance on 24th January. Most economists prefer a pause mode on rate while highlighting the need for CRR cut to address liquidity concerns. It is pointed out that elevated core inflation (despite sharp downtrend in food and primary articles) may delay the shift in monetary policy stance from anti-inflation to pro-growth. It is a fair point. RBI’s worry on inflation grew on possible rupee impact on inflation when rupee was threatening to extend its weakness beyond 54 into 56-58. But, now rupee fortunes have reversed for extension of gains below 51. On the other hand, commodity prices are also providing topping out signals for sharp reversal into the short/medium term. The other major issue is the high fiscal deficit which is anti-growth. Now that weak rupee (pro-inflation factor) fears are out of the way, there is strong case for RBI to address the anti-growth factor (high fiscal deficit) through monetary actions. RBI has other options to inject rupees into the system through USD purchases (in FX spot market to arrest excessive rupee gains) and Buy/Sell swaps (in the forward market to arrest higher premium and its negative impact on Money Market rates) and can afford to delay CRR cut and reduce OMO operations; thus rate cut action (ahead of CRR cut) becomes relevant to trigger reversal in monetary policy stance. Therefore, it would not be a surprise to see start of reversal in interest rate cycle on 24 January through delivery of 0.5% CRR cut and 0.25-0.5% rate cut. This stance will be good for Bond and Equity market while arresting spike in short term money market rates.
Currency market
USD/INR moves have been volatile but stayed predictable up to reversal into 51 from 54; extended gains below 51 is a surprise. We had considered value around 53 good to sell 3M forward dollars and around 52 good to cover 3M imports; accordingly had set 52.75-53.25 as sell zone and 52.25-51.75 as buy zone. This expectation was supposed to provide stability in spot dollar at 51-52; however high FX premium (3M spike into 8%) provided test/break of 51 into 50.70. Over all, the market has given opportunities to both; exporters to cover 3M receivables (high of 52.84) and importers to cover 3M payables (low and close at 51.75). What next? RBI has done its best to cut abnormal demand and accelerate supplies. FX strictures on corporate and inter-bank speculation and deregulation of NRE interest rates have helped. The interest rate play (high FX premium) is also strongly in favour of rupee bulls. Now, RBI has increased the import duty on bullion to cut dollar demand from bullion purchases. Rupee bulls are back into street with strong force, thanks to RBI’s aggressive measures. Greed and fear factor has come into play now. Exporters who missed spot rupee move into 54 are in fear for their life (leading dollar supplies) while importers who stayed uncovered on expectation of move into 51.50-51.00 are greedy (lagging dollar demand) on hope of extension into 48.70. This has brought the lead-lag mode into play; exporters in aggressive sell mode while importers delaying dollar purchases. Not ruling out this kind of reversal of fortunes for rupee; it was advised to sell long term dollars (1/3/5/7 years) to shift rupee liability to dollars and NRIs to lock into 3-5 years NRE deposits on spot weakness into 53.50-54.25. The reversal of fortunes was swift and strong. Now, immediate support for USD/INR is at 50.50 ahead of 49.85. RBI has validated its earlier stance that extended rupee weakness was driven by speculation and not weak fundamentals. There is zero arbitrage between NDF and domestic forward market as 3M NDF and 3M outright forward in domestic market trades around same levels. RBI firmly believes that “run” on rupee from 48.61 (31st October) to 54.30 (18th December) was driven by speculation. RBI took all steps including strictures on FX operations to unwind this excess weakness driven by speculation. If this observation is valid, will rupee revisit 48.60? Let us see. Now, USD/INR will find resistance at 51.00-51.20 attracted by higher premium. This sets up near term range play at 50-51 not ruling out extension into 49.85. Sell zone for 3M forward dollars is now at 52.00-52.25 while 3M dollar expected to find support at 50.75-51.00. It is possible that rupee moves now get into traction with USD Index (and the EUR/USD). USD Index has come off from strong resistance at 81.50 but the correction process should stay above 80.50 for move into 82.50-83.00 soon.
EUR/USD has held well at support zone of 1.2650-1.2550 (low of 1.2623) for correction into sell zone of 1.2750-1.2825 (high of 1.2808). Given the possibility of emergence more weak news from Euro zone (and few positive news from the US zone), EUR/USD trend is down for extension into 1.2550/1.2250/1.1950 into the near/short term. We are already into short term trading range of 1.1850-1.3150 with “inner ring” play within 1.2450-1.2850. It is prudent to trade end-to-end of this range for now. USD/JPY is now taking a “knock” at 76.50 support (low of 76.54) and looks set for extension into 75.50 from where a sharp reversal may be on cards while 77.00-77.25 attracts selling interest. Stay a cautious seller for this move and stay “long” above 75.50 for the next big move into 78.25 ahead of 80.
FX premium back into bullish mode to test/break 8% in 3M and 5.75% in 12M driven by exchange rate play (reversal in spot rupee from 51.80 to below 51); higher premium beyond this level will have negative impact on the money market. It is good opportunity for RBI to get into B/S mode to pump rupees into the system. So, it is not prudent to chase rally beyond 8% in 3M and 5.75% in 12M. Given the rate cut expectation on 24th January, tighten your belt for sharp downturn into 6.5% in 3M and 4.5% in 12M. Let us now watch bigger range of 6.5-8.0% in 3M and 4.5-5.75% in 12M. It is very good opportunity for rupee surplus Banks to absorb this rally. Exporters can switch to fund 3M PCFC in rupees and sell forward dollar for an interest arbitrage of 1.0-1.5%.
Bond/OIS market
10Y bond yield traded end-to-end of 8.15-8.25% range; rising sharply from 8.13% to 8.24% before stability above 8.20% for close at 8.22%. Now, trigger of rate cut by RBI on 24th January is considered good to stay “long” in 10Y bond into 8.25-8.35% for 8.10%. It is not prudent to expect a rally beyond 8.10% given the issues relating to high fiscal deficit; supply concerns and infusion of rupee liquidity through FX market, thereby cut in OMO operations. Till then, we watch consolidation at 8.15-8.25% with test/break either-way to attract.
OIS held above the support of 7.75% in 1Y (low of 7.81) and 7.0% in 5Y (low of 7.04%) for sharp reversal into 8.08% and 7.27% before close at 8.06% and 7.27% respectively. While 5Y rate found good resistance below 7.30%; spike in 1Y above 8% was driven by high call money rate into 9.5%. For now, we watch ranges of 7.75-8.10% (1Y) and 7.05-7.30% (5Y). It is not safe to stay paid at 8.05-8.10% (1Y) and 7.25-7.30% (5Y) as reversal into the set pay zone of 7.75-7.65% (1Y) and 7.0-6.90% (5Y) will be swift.
Commodity market
Gold traded end-to-end of set inner ring of 1630-1670 (within near term range of 1600-1700) for decent rally from low of 1631 to 1667 and looks good for consolidation at 1630-1680 before reversal into 1600-1580. NYMEX crude held its support well at 98.00 for rally from low of 97.70 into sell zone of 100-102 (high of 101.29). Let us continue to watch for consolidation at 98-103. Over all, preparation is on for sharp reversal into 92-90.
NIFTY
The S&P downgrade of most of Euro zone countries did not cause any damage as initial weakness into 4827 was followed with sharp rally into 4975 before close at 4967. There is more pipe-line negative news from the Euro zone but domestic cues are now supportive of equity assets. The shift of fortunes for rupee and rate cut expectation on 24th January will keep the market steady to mildly bullish mode for now. Taking all these into account, we may need to shift our near term range at 4650-5150. Strategic investors who bought one-third of appetite at 4550 (on recent run into 4531) can look to exit for 500 pip profit. Fleet footed traders can play end-to-end of 4850-5150 with tight stop on break thereof.
Have a good day ahead.....................Moses Harding
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