MARKET PULSE: Weekly report for 19-23 March 2012
Thumbs down to reforms and populist measures but intent on fiscal consolidation
There was no disappointment (neither pleasant nor unpleasant) from the Budget FY13 and the FM has done well within the available means; defensive and firm. FM did not have the bandwidth to go big-bang on reforms (economic or structural) to ramp up revenues or to cut subsidies to manage cost efficiency. Our expectation revolved around the main themes of GDP growth at 7.5%; fiscal deficit at 5%; net market borrowing of around Rs.4.5 Trillion; higher taxes (and coverage) to bridge fiscal gap and measures to ensure flow of cost subsidisation to the right target segment. It was also considered essential to pull off-shore liquidity to infrastructure and ensure availability of domestic investments to core sectors. The actual numbers are more or less in line with expectation with FY13 estimates of 7.6% GDP growth; 5.1% fiscal deficit with slippage in net market borrowing at Rs.4.8 Trillion and disinvestment target of Rs.40K Crores. The placement of cap at 2% of GDP for cost subsidisation without keeping it open-ended is a welcome move. The plan to make direct cash transfers through Unique ID system will avoid leakage in subsidy distribution and ensure reach to right audience. There are measures for infrastructure companies to access off-shore markets for debt and increase in issuance of tax-free bonds to domestic investors. It was not a surprise to see increase in taxation (move close to 2008 levels) and cutting the negative list for service tax for higher coverage. The FM has also released pressure on Current Account Deficit through higher taxes on import of Gold and precious metals. All other major aspects linked to economic or structural reforms are untouched. Over all, FM was not expected to do better than this given the political limitations and economic (and monetary) complexities on hand. But, this is not good enough to send bullish signals for the way forward. At best, FY13 could be a period of consolidation while the Government (and RBI) work for solutions to get the economy out of the vicious trap; caught between low growth and high inflation dynamics. There has to be a priority shift (from inflation to growth) to get the economy back on track. The phase since March 2010 to arrest inflation has been long and shift from neutral stance to growth supportive stance will help the Government to achieve the set targets. It is not that RBI has not done enough. It has pumped in huge liquidity; primary cash of over Rs.2 Trillion through OMO and 125 bps CRR cut and daily cash of over Rs.1 Trillion through LAF counter. But there is need to address cost of liquidity to pump up consumption and productivity. It is also important for the Government to address supply side concerns to get out of this trap firmly and quickly. Else, the chicken and egg situation will stretch further into FY14! To sum up, the Government stands exposed with no political power to bite the bullet or deep pockets to chew the ballet. What is the impact on markets?
Fixed Income (Bond/OIS) market
The draw down from LAF has crossed over Rs.1.75 Trillion (against the expected cap of Rs.1.5 Trillion for the week) and money market rates are through the roof with 1-3M rates above 12% and 6-12M rate at 11.0-11.5%. The shift into the second week of the current reporting fortnight cycle ending 22nd March will provide bit of relief. We would see significant release of pressure from new reporting fortnight starting 23rd March to drive the LAF draw down to below Rs.1 Trillion and shorter end of the rate curve below 11%. The deficit system liquidity is expected to be around Rs.50-75K on shift into FY13. Going forward, RBI is expected to maintain system liquidity around its comfort level of 1% of NDTL with mix of OMO bond purchases and CRR cuts. There is now divided house on expectation of rate cut in April annual policy review. The expectation now is for shift of LAF corridor into 7.0-8.0% by end of Q1/FY13 through 50 bps cut in policy rates. Thereafter, the timing of allowing pass through of operative policy rate from higher end to lower end of LAF corridor will be dependent on trending in headline/core inflation; BRENT Crude below $115 and rupee stability below 50. RBI should derive comfort from FM’s actions (and intent) to address fiscal consolidation. For the week, let us watch overnight MIBOR trending below 8.75% with LAF draw down below Rs.1 Trillion by close of week. There will be relief in term money market with rates trending down (beyond 3M tenor) despite higher demand from Banks to meet financial year end targets.
Bond market is in strong bear grip post monetary policy and the Budget. 10Y bond yield rose sharply into 8.45% on emergence of supply side concerns. RBI was able to address this issue through aggressive OMO purchases to the tune of over Rs.1 Trillion. If structural liquidity position becomes normal, then RBI may discontinue with its OMO operations; this is the fear at this stage. The system is already in excess SLR mode by over 4% of NDTL and there may not be demand till RBI gets into rate cut mode. Our “call” to cut policy rates by 50 bps was to maintain stability in 10Y bond yield at 8.10-8.35% to cover post-budget bear run and now RBI has to prepare for defending extended weakness beyond 8.50% to guide stability at 8.35-8.50% till trigger of rate cut. Now, the negative spread between 1 and 10Y bond yield will vanish to build tenor premium of minimum 10-15 bps. For the week, let us watch 1Y & 10Y bond yield at 8.35-8.50%. The bias in 1Y will be to the lower end while 10Y yield knocks at 8.50% to build premium of 15 bps across 1-10Y tenor. The strategy is to stay invested in 1Y bond 8.45-8.50% and await fresh cues to absorb weakness above 8.5% in 10Y (not ruling out extended weakness into 8.65%). The shift of focus into 8.20-8.15% is dependent on 50 bps rate cut and shift of operative policy rate into the lower end of LAF corridor.
OIS rates moved up tracking higher overnight/term MIBOR and bearish set up in the bond market. 1Y OIS rate was up into 8.25% and 5Y into 7.65%. Here again, the play will be on the spread squeeze with strong resistance in 1Y at 8.25% and good support in the 5Y at 7.55%. We highlighted the risk of extended weakness in 5Y rate above 7.55% if RBI leaves rates unchanged and advised traders to play stop/reverse strategy. Now, short term range play is expected to stay within 8.0-8.25% in 1Y and 7.55-7.80% in 5Y. For the week, let us watch 1Y at 8.15-8.25% and 5Y at 7.55-7.75%. The strategy is to receive 1Y at 8.25-8.30% and pay 5Y at 7.55-7.50%. The downtrend in money market rates and uptrend in medium/long tenor bond yields will limit extension beyond 8.30% in 1Y and arrest sharp reversal in 5Y below 7.50%.
Currency market
There is bit of relief for rupee from the Budget on commitment to keep Current Account Deficit much lower than the FY12E of 3.6% of GDP. FM has also taken measures to remove the bullion impact on the CAD and has cut the round-tripping trades in precious metals which are anyway neutral on the CAD. However, risk will be from FII interest in domestic stock market. There is no change in our stance of looking for short term consolidation at 49.80-50.50 with overshoot limited to 49.50-50.80. We continue with the strategy to sell 1M/April dollars above 51 (spot at 50.50-50.60); 3M/June dollars above 52 (spot at 50.85-50.95) and December 2012 dollars above 53 (spot at 50.35-50.45). On the other side, importers can cover 1-2M imports at 49.85-49.60. Over all, impact from the Budget is neutral at this stage and rupee direction will be driven by movement in USD Index and crude oil price. USD Index is now in consolidation mode at 79.50-80.50 unable to hold on to its gains above 80.50 but it is matter of time for extended gains above 81 with 79.20 forming a strong short term base. We need to have a close watch on FII behaviour. It is possible that FII may get into profit booking mode in the absence of appetite from domestic investors. For the week, let us watch rupee at 49.80-50.65 with test/break either-way not expected to sustain. Strategic players can look to play end-to-end of this range by buying at 49.80-49.65 and selling at 50.65-50.80 with tight affordable stop. Let us also look to exit December 2012 “shorts” entered above 53 for 50 pip profit on spot move into 49.85 (December 2012 dollars value below 52.50).
There is no change in FX premium outlook for consolidation in 3M at 8.0-8.75% and 6.0-6.5% in 12M. It is prudent to play end-to-end of these ranges as test/break either-way is not expected to sustain. It is good to receive June 2012 at 8.5-8.75% for ALM play (to fund PCFC book of L+3.5%) and to pay 12M below 6% for conversion of FC sources into rupee uses. There will be good arbitrage on these carry trades. It would need extended rupee weakness beyond 50.80 to drive premium down; very low probability at this stage. Strategic players can look to receive 12M at 6.50-6.65% and pay at 6.0-5.85%.
EUR/USD held well at set buy zone of 1.3000-1.2975 (low of 1.3002) to complete the correction phase by revisit into 1.3175-1.3200 sell zone (high of 1.3184); hence the suggestion to exit “shorts” above 1.3000-1.2975 and “buy” there for correction back into 1.3150-1.3200. What next? EUR/USD has moved into consolidation mode at this stage; weekly close above 1.3150 provides comfort to Euro bulls for extended gains into 1.3250-1.3300 while 1.3050-1.3000 remains firm. For the week, let us watch 1.3050-1.3250 with overshoot limited to 1.2975-1.3325. The strategy is to play end-to-end by selling at 1.3250-1.3300 (with stop above 1.3325) and buy at 1.3050-1.3000 (with stop below 1.2975). Let us stay neutral on break-out direction and await fresh cues to provide momentum.
The rally in USD/JPY lost momentum ahead of strong resistance at 84.25 (high of 84.17) and in consolidation mode at 83-84. The rally in USD/JPY from 76.02 (2/2/12) and 80.56 (7/3/12) is sharp and it would be in order to allow for consolidation in the near term and await fresh cues for directional break-out. For the week, let us watch consolidation at 82.50-84.25. There is no clarity on directional break-out at this stage which could extend to 81.75 or 85.50. Let us stay aside for now and stay tuned to convert the JPY liability (entered below 76.50) back into USD on move into 85.00-85.50.
The rally in EUR/JPY from strong support zone of 105.75-105.25 has hit 110 for a 450 pip rally. This pair is looking good for extension into 111.50 while 108.50 provide good support. For the week, let us watch consolidation at 108.50-111.50 with initial bias into higher end. It is possible that we see sharp reversal from there into 108.50; break of which will extend to 107.50/105.50. The strategy is to sell at 111.25-111.75 (with stop loss above 112) for 107.50-107.00.
Equity market
NIFTY is down triggered by disappointment in mid quarter review of monetary policy (15th March) followed by absence of optimism in Budget 2012 (16th March). It is good that we had turned neutral ahead of budget asking investors to shift from equity to high yield fixed income and pre-budget rally into 5445 gave good exit (on long entered at average 5225) while weekly close below 5350 is bearish. What next? NIFTY rally from 4531 (20/12/11) to 5630 (22/2/12) was triggered by external cues despite negative sentiment in the domestic environment. During this time, DJIA rallied from 11735 to 13253 with gain of around 13% in three months time. NIFTY outperformed DJIA with gain of around 24% in two months time mainly driven by flow of FII liquidity into Indian equity market. Normally, FIIs don’t prefer consolidation market to stay invested with exchange rate risk. The bull-run since shift into 2012 is losing steam with no bullish expectation from the Budget and NIFTY is expected to stay in sideways trading mode into short/medium term. Given this expectation, it is possible that FII will get into wait-and-watch mode or slowly retreat from the scene. NIFTY is definitely in downtrend at this stage posting lower high’s (from 5630 to 5499) and it is important to hold at the strong support zone at 5170-5195 to prevent extended weakness into the lower end of set near term range of 5000-5500. The positive sentiment in DJIA would provide bit of relief; expectation is for gradual move into 14198 (level seen in October 2007 which triggered post Lehman collapse to 6470 by March 2009 in 18 months). DJIA is in the process of regaining the entire fall from 14198 to 6470. On the other hand, NIFTY is moving away from pre-Lehman high of 6357 (January 2008). As said, Indian economy is caught in vicious trap between growth and inflation. The authorities need to quickly shift priority towards growth to get the market out of its woods. For now, let us watch immediate supports at 5175 and 5080 which will come into play this week. Beyond there, it is important that this bear run lose momentum at 5000-4950; else recent low of 4531 will come into focus. The bulls need to take out strong resistance at 5400-5450 (ahead of 5525) to prevent bear set up in the market. For the week, let us watch 5075-5400 with overshoot limited to 4950-5525. The strategy is to play from “short” side by selling in two lots at 5400-5425 or/and 5500-5525 (with stop above 5550) for 5000-4950. Strategic investors can stay away for 5075-4950 and await trade initiation signals.
Commodity market
Gold is in consolidation mode at 1635-1665 for close of week at 1650; midpoint of the set near term range of 1600-1700. The moves in Gold are in alignment with USD Index. Given the consolidation mode in USD Index at 79.50-80.50 (within 79-81); Gold is expected to stay in consolidation mode at 1615-1685 (within 1600-1700). The strategy is to play the inner ring of 1615-1665 (for fleet footed traders) while strategic players can look to sell at 1685-1700 and buy at 1615-1600 with tight affordable stop.
NYMEX Crude traded end-to-end of set near term range of 103-108 (low of 103.78 and high of 107.34) before close of week at 107.15. The inability to hold below 105 highlights the strength of the bulls but given the strong political support to arrest excessive rally, bulls are not expected to chase gains into 108-110. For the week, let us continue to watch consolidation at 103-108 (within 100-110). Fleet footed traders can play end-to-end of 103-108 while strategic players can look to sell at 108.50-109.50 (with stop above 110.5) for 104.50-103.50.
Have a great week ahead................Moses Harding
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