Rupee liquidity squeeze.....market looks up to RBI for breadth!
It was not surprise to see draw down from LAF counter exceed Rs.1.5 trillion, thus pushing overnight MIBOR into 9.5% and short term money market rates into double-digit. The surprise is the sustainability of rupee liquidity shortage at over 3% of NDTL as against RBI’s tolerance level of 1%. RBI has restricted its agenda to manage Government borrowing schedule to match its bond supplies with OMO purchases but has not done enough to address concerns of other stake holders in the system. The demand for rupee funds has risen sharply since the Euro zone crisis. There was significant squeeze in availability of dollar liquidity squeeze since August 2011 pushing Banks to fund US Dollar gap through Buy/Sell swaps which pushed forward premium to very low levels. This was followed by rupee weakness (run from 44 to 54) which diverted USD carry trades to rupee. Now, high FX premium is driving Export Credit into rupees. It makes good business sense to avail rupee export credit at base rate of say 10.5% and sell 3M dollars forward at premium of 8.5% to restrict the dollar rate at 2% as against current L+3.5% (plus other charges). RBI also has sucked out rupees out of the system through its USD sales to prevent run on rupee. RBI has not yet turned into USD buy mode despite extended rupee gains below 51.00. With all these market dynamics; it was not a surprise to see significant pressure on rupee liquidity. It is high time to act to prevent draw down from MSF counter at 9.5%; carrying risk of overshoot in call money rate into double-digit. RBI has lot of options on hand to provide rupees into the system: (a) CRR cut – may not be very effective given the huge appetite for rupee funds; (b) USD purchases in the spot FX market – would help to arrest excessive rupee gains and spike in forward premium and (c) Buy/Sell swaps in FX swap market – to arrest shift of rupee funds from domestic system into nostro accounts. While it is not possible to provide SLR cuts given the huge appetite from the Government, RBI could look at increasing the MSF limit from 1% to 3% and align the MSF rate to Repo rate; thereby allowing Banks a higher dip into SLR book and arrest spike in call money rate into double-digit. Let us see what is in store? The need is critical as we move into financial year-end leading to higher demand for funds from Banks and borrowers. The system is already operating at 1% over operative policy rate of 8.5%; thus making rate cut not very relevant at this stage. So, we believe all these aspects will be addressed on 24th January policy review. The current situation of tight liquidity and high cost of liquidity is strongly anti-growth and there is immediate need to provide course correction to shift market conditions to neutral-growth before shift into pro-growth.
Currency market
Rupee extended its rally to take out immediate resistance of 50.50 for run into the next one at 49.85-50.00. The break of which will bring the focus into 48.60; thus providing 100% reversal of the rupee fall from 48.61 to 54.30 from mid October to mid December. Over all in retrospect, RBI’s measures of cutting corporate/interbank speculation and opening up the dollar supplies from NRI/FII investors have been proved good in short span of a month. Good job done, RBI. Now, rupee fortunes have turned from negative to neutral. While issues relating to current/trade account stay valid, there seems to be no worry on capital account; at least in the short term. There will be availability of external liquidity to bridge gap in trade/current account. The high FX premium will keep the forward market in supply driven mode; thus adding to supplies in the cash market. Having removed abnormal demand from the system and trigger of lead-lag play (exporters accelerating forward supplies and importers holding back forward dollar purchases), cash market will stay in supply driven mode leading to rupee bullish momentum in the near term. In the given market dynamics, it would need RBI to prevent test/break of 49.85 to arrest extended run into 48.60. In the meanwhile, aggressive funding support to Euro zone has cut the bullish momentum in USD Index for sharp reversal from above 81.50 to below 80.50. For now, let us watch consolidation at 49.85-50.50 and consider good to sell 3M/April 2012 dollars at 51.60-51.75 while it is prudent to buy January 2012 dollars below 50.00. Over all, rupee seems to have settled into a new short term range of 49-51. RBI has so far been in USD sell mode and possible shift into USD buy mode will bring the focus back into 51-52. We need to have this scenario on back of our mind as low inflation and downtrend in commodity prices can swiftly push USD/INR into 51-52; hence not to take the market for granted. At this stage, it is difficult to take views beyond 3 months; hence restricting trade strategies to January-April 2012.
We reviewed yesterday the near term range for EUR/USD into 1.2650-1.2950 and considered good to sell 1.2875-1.2950 (with stop at 1.2975) and have seen high of 1.2972. We did see reversal from 1.2875-1.2900 but it was shallow to hold above 1.2835. The extension of financial support from IMF has given bit of relief. But it is fair to assume that all these supports will only provide temporary relief while hurting medium/long term recovery. Euro zone at this stage is not seen to be out of the worst; hence any recovery for EUR/USD shall be short-lived. There is no change in our short term range of 1.1850-1.3150 with gradual bias into lower end. The near term range is reviewed to 1.2650-1.3000 with overshoot limited to 1.2450-1.3150. The strategy is to stay “short” for move into lower end in due course. USD/JPY is boxed at 76.50-77.25; more the consolidation within this range, higher is the chance of revisit into 75.50 to shake up BOJ. With EUR/JPY below 100, it is high time for BOJ to act SNB way. Let us be cautious buyer between 76.50-75.50 for push back to 78.25 ahead of 80; expectation of reversal into 85-90 is still valid. Those borrowers who shifted rupee liability into US Dollars on rupee weakness into 53.50-54.25 can now shift USD Dollar liability into JPY at 76.50-75.50 to reap the most benefit.
The spike in call money rate into 9.5% and rupee gains into 50 continue to keep FX premium in bullish mode with 3M into 8.5% and 12M into 6%. The combination of interest and exchange rate play has come good for the bulls. The market is now in unsustainable territory as it was when 3M traded below 1% and 12M below 2%; therefore sharp reversal is due. It is not the time to panic and could afford to stay “received” incurring higher carry. Alternatively, it is good risk-reward to receive Jan/Dec current at 271-278 (5.85%-6.0) for reversal into 5% (230). Those exporters who are partly covered on rupee weakness into 53.00-54.25 can absorb higher premium while awaiting reversal in spot rupee into 51-52.
Bond/OIS market
The market is in consolidation mode with mixed signals. Rate cut hopes and shift into easy monetary policy soon is providing stability in 10Y bond yield at 8.15-8.25% while tight liquidity and high overnight MIBOR remains strong support to delay downtrend in OIS rates. Over all, the spike into 8.05-8.10% in 1Y and 7.25-7.30% in 5Y could not sustain for stability below these resistance levels. No change in view as we look for consolidation in 10Y bond at 8.15-8.25%; 1Y OIS at 7.95-8.10% and 5Y OIS at 7.15-7.30%. Strategy is to buy 10Y bond on weakness into higher end (8.22-8.25%) and stay received in OIS on strength into 8.10% in 1Y and 7.30% in 5Y. It is matter of time before we move into set pay zone of 7.75-7.65% in 1Y and 7.05-6.95% in 5Y. It is possible that 10Y bond yield settles into 8.0-8.25% post policy with test/break either-way not expected to sustain. For now, external cues (higher EUR/USD and marginal upticks in US Treasury yield) will arrest extended gains into 8.15-8.10% for reversal into 8.20-8.25%.
Commodity market
Gold in consolidation mode at 1630-1680 and the bias in neutral for directional break-out although would prefer one-touch into 1600-1580. It is better to stay neutral and look for selling extended gains into 1680-1710 with tight stop for 1600-1580. NYMEX crude is boxed at 100-102 with no momentum either-way. Let us stick to near term consolidation at 98-103 with test/break either-way not expected to sustain.
NIFTY
Positive external cues driven by extended financial support to Euro zone and possible shift of RBI’s monetary stance from anti-inflation to pro-growth soon has brought the bulls back into the street. However, the momentum is slow for gradual gains into 5000 from the recent low below 4550. The positive take-away is significant dilution in the bearish undertone for shift into mildly positive mode. We continue to watch consolidation at 4850-5150 with near term bias into higher end not ruling out extension over 5150 on RBI sending pleasant surprise signals into the market. Strategic investors who bought one-third of the appetite on weakness into 4550 can run the position with trail stop at 4850 for 5150. Fleet footed traders can now buy weakness into 4950-4850 for 5150. There are signs of investors moving away from “risk-off” mode into neutral and prepare for shift into “risk-on” mode.
Have a good day and great weekend ahead.................Moses Harding
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