MARKET PULSE for the week 16-20 April 2012
Monetary Policy expectations (major indicators):
CRR/SLR unchanged
50 bps cut in Repo/Reverse Repo rate
Growth projection at 7.5% with downward bias
Inflation projection at 6.5% with neutral bias (linked to crude oil and rupee behaviour)
Credit growth projection at 14-16% with downward bias
Deposit growth projection at 16-18% with downward bias
There is no serious concern on liquidity; deficit system liquidity (on reporting fortnightly average basis) is now around RBI’s comfort level of 1% of NDTL; probability of CRR cut is low, having delivered 125 bps cut (primary cash infusion of Rs.1.6 Trillion) since January 2012. The focus will now shift to cost of liquidity to enable Banks to cut lending rates. The other agenda is to support Government in its efforts to achieve FY13 GDP growth target of 7.6% and arrest fiscal slippage in FY13 beyond 5.1% target; most stake holders are not optimistic on achieving these targets without monetary support. It would need shift into adequate (or surplus) system liquidity at affordable cost to achieve the set FY13 targets. A token rate cut (of 25 bps) may not help at this stage. If RBI has to endorse (or concur) with Governments’ FY13 target of 7.6% GDP and 5.1% fiscal deficit in their annual policy estimates, delivery of 50 bps rate cut looks certain. It may not be an easy decision for RBI given its concerns on inflation and exchange rate; there seems to be no other option but to “bite the bullet”! The tone of the policy may not be dovish but expected to be neutral with dovish bias if factors considered as major risks to inflation shape up to expectations; thus providing signals for CRR cuts in due course to drive operative policy rate from Repo rate to Reverse Repo rate, with an effective 150 bps rate adjustment (from current 8.5% to 7.0%) before end of Q2 of FY13. Over all, expectations of 50 bps rate cut and 125 bps CRR cut through H1 of FY13 remain unchanged. Thereafter, would look for stability with operative policy rate at 7% and CRR at 3.5% through H2 of FY13 and need-based liquidity injection to be done through OMOs to maintain operative policy rate at Reverse Repo rate; there is no case for SLR cut at this stage till fiscal prudence is achieved.
Interest rate market
Money market is steady (and back to normal) on shift into FY13; short term money market rates are down sharply into 9.0-10.0% across 3-12M tenor from the peak of 11.5-12.0% and deficit system liquidity is down below Rs.1 Trillion. However, Bond market has been volatile (in the medium to longer end) boxed between supply side concerns and strong expectation build-up for shift into dovish monetary policy stance by RBI. 10Y bond yield is down sharply from recent high of 8.79% to below 8.5% for close of week at 8.46%. The strategy to stay invested in 1Y bond at 8.45-8.65% (current 8.25%) and 1Y OIS at 8.15-8.25% (current 7.92%) has proved good and would get exit on post-policy rally into 8.10-8.0% (1Y bond) and 7.85-7.75% (1Y OIS). As mentioned in the report (What to expect from RBI on 17th April?, released on 11th April), 10Y bond yield has already moved into 8.25-8.5% range while 5Y OIS not getting enough momentum to take out strong support at 7.5% (close of week at 7.52%). Here again, bond swap strategy to buy 10Y bond above 8.65% with 5Y OIS hedge around 7.5% has proved good (with both positions in profit); spread is now squeezed from over 110 bps to 90 bps.
What next? The shift into second week of reporting fortnight cycle ending 20th April will push draw down from LAF counter to below Rs.50K Crores and cut the gap between Repo rate and overnight MIBOR. It is time to look for move into the lower end of set short term ranges of 8.0-8.5% (1Y bond) and 7.75-8.25% (1Y OIS). Having seen test of higher end in the second fortnight of March, we are not far away from test of lower end. It is also fair (and prudent) at this stage to look for consolidation in 10Y bond at 8.35-8.50% with extension limited to 8.20-8.65%; hence strategy (for short term players) would be to unwind longs on extended gains into 8.35-8.20% and stay invested on weakness into 8.50-8.65%. This would set up consolidation in 5Y OIS rate at 7.40-7.60% with test/break either-way not expected to sustain; spread between 10Y bond yield and 5Y OIS rate is now expected to stay in consolidation mode at 90-110 bps till shift of operative policy rate from Repo rate to Reverse Repo rate. The chances of overnight MIBOR trending below 7% in coming years is very low; hence it is not a good risk-reward to stay “received” in 5Y OIS below 7.5%. It would be good for companies to “borrow short” to earn tenor premium with 5Y OIS “pay” hedge below 7.5%. For the week, let us watch 1Y bond at 8.10-8.25% and 1Y OIS at 7.75-7.95% with bias into lower end. On the longer end, watch 10Y bond yield at 8.35-8.55% and 5Y OIS rate at 7.45-7.60% with test/break either-way not expected to sustain for long.
FX premium did over-shoot marginally beyond strong resistance at 8% in 3M and 6.25% in 12M and reversal from there held at 7.5% and 6.0% respectively before close of week at 7.7% (3M) and 6.1% (12M). Let us continue to stay with the set short term range of 7.0-8.0% (3M) and 5.75-6.25% (12M) with bias into lower end; trigger will be from rate cut action from RBI. These ranges (on 3M and 12M) has factored 50 bps rate cut and test/break below lower end will need shift of system liquidity from deficit to surplus mode; not expected to happen in the short term. It is also important for premium to stay at elevated levels to avoid pressure on spot rupee market from forward market. For the week, let us watch 7.0-7.75% (3M) and 5.75-6.10% with bias into lower end. The risk of test/break higher will be on strong exchange rate play driving spot rupee below 51.00. The strategy is to unwind “received book” (initiated at the higher end of set ranges) at 7.15-7.10% (3M) and 5.80-5.75% (12M) and await fresh cues for the next move.
Currency market
It was a good 35 pip trade from 51.44 to 51.06 and then from 51.64 to 51.29 before close of week at 51.30. Over all, two zones identified as good dollar supply zone at 51.40-51.45 and 51.60-51.65 held well to provide decent intra-day/over-night trading opportunity. The move to 51.60-51.65 triggered sale of December 2012 dollars above 54.00 (current at 53.67) and March 2013 dollars above 54.65 (current at 54.28). What next? There is no clear trend at this stage with rupee fundamentals remaining weak and vulnerable. Rupee fortunes now revolve around three critical factors; sustainability of FII flows, high FX premium and USD Index staying below 80. There seems to be no concerns from FII flows and FX premium; shift into growth-supportive monetary stance and resultant rally in equity market will attract FII interest despite issues related to GAAR and RBI can maintain higher FX premium through deregulation of FCNR rates and relaxation in off-shore borrowing limit for Banks. The critical factor is now the behaviour of USD against major currencies and the direction/trend revolves around QE3 at this stage. It is good for rupee bulls to see USD Index unable to hold on to its gains above 80 but reversal from there is shallow. Till we get clarity on QE3, USD Index is expected to stay in consolidation mode at 78.60-80.20 with overshoot limited to 78.10-80.70. Taking all these together, short term range for USD/INR pair is expected to be at 51.05-51.65 with overshoot limited to 50.65-52.05. It would need combination of good FII flows and weak USD Index to get the focus back into 50.30-49.80; not ruled out at this stage. Over all, downside risks to rupee is expected to stay limited to 52.05 while upside gains can extend all the way to 49.80. The strategy to sell December 2012 dollars above 54.00 and March 2013 dollars above 54.65 is valid; which could give a 50-75 pip profit in quick time for short term traders. For the week, let us watch consolidation 51.15-51.65 with overshoot limited to 50.90-51.90; immediate bias is for move into 51.65-51.90 which should hold. Strategic traders can look to sell in two lots at 51.60-51.65 and 51.90-51.95 for reversal into 51.15-51.10 and thereafter into 50.90-50.85. It is important for RBI to cut the interest rate play on FX premium to arrest interest rate driven rupee weakness beyond 51.65-51.90; else we get the focus into 52.05-52.20 before strong reversal. We need to keep this at the back our mind at this stage. However, there may not be significant change on the value of December 2012 and March 2013 dollars; hence the strategy to sell December 2012 dollars above 54.00 and March 2013 dollars above 54.65 to absorb higher premium (ahead of interest rate play) while enjoying time decay.
EUR/USD held above strong support zone of 1.3025-1.2975 (low of 1.3031) and bounce from there has been sharp into the immediate resistance zone of 1.3175-1.3225 (high of 1.3212) for close of week at 1.3075. EUR/USD is weak having come off sharply from above 1.32 and it is important for strong support at 1.3000-1.3035 to hold to maintain neutral (and consolidation) undertone within 1.30-1.33 into the near term; else 1.2900 comes into play to prevent extended weakness into 1.2625. For the week, let us watch 1.29-1.32 with bias into lower end. Intra-day traders can stay “short” for this move while strategic players can choose to play end-to-end by selling at 1.3175-1.3225 (with stop above 1.3250) and buying at 1.2925-1.2875 (with stop below 1.2850).
USD/JPY pair is able to hold on to its weakness above strong support at 80.50 (low of 80.57) but recovery from there is very shallow for close of week at 80.90. Now, we may need to allow extended correction below 80.50 to 79 before reversal while 81.75-82.00 stays firm. For the week, let us watch 79-82 with bias into lower end which should hold. The strategy is to play end-to-end by selling at 81.50-82.00 (with stop at 82.25) and buying at 79.50-79.00 (with stop at 78.75).
EUR/JPY is holding well above strong support at 105.50 but continues to stay in bearish set up given the downside pressures on both EUR/USD and USD/JPY. The near term range now stands shifted to 102.50-107.50 with bias into lower end. The strategy is to trade from “short side” for this 250-300 pip move below 105.50.
Equity market
NIFTY got good support at buy zone of 5225-5175 (low of 5190) but rally from there lost steam at 5306 before close of week at 5207. In the meanwhile DJIA held well at the strong support zone of 12750-12700 (low of 12710) for rally back to 12998 before close of week at 12850. The weekly close in NIFTY within 5225-5175 is neutral but would be seen as bulls losing the advantage. The near/short term outlook is not bearish but there are no strong signals for bull trend. While external cues are neutral (to supportive), attention will be on RBI’s Annual Monetary Policy review to provide directional break-out. The ability to hold above short term support at 5175 is positive and it would need RBI’s shift into growth supportive monetary policy stance to post strong rally through 5379; 5499 and further into short term objective at 5630. Any disappointments from RBI will be very bearish for swift fall below 5136 into 4588-4531. Let us not prefer this scenario at this stage. The momentum to this rally will be from western bourses and it is important for DJIA to stay above strong support zone of 12750-12700 for gradual move above strong resistance at 13300 (to reclaim recent high near 13300). Our expectation is to look for short term consolidation at 12700-13300 in DJIA and 5125-5625 in NIFTY with bias into upper end. For the week, let us watch consolidation at 5175-5375 and await post-policy break-out into 5500-5625 while extended weakness to find strong buying above 5135. It would be a very good risk-reward trade to buy at 5175-5125 (with stop below 5100) for 5500-5625.
Commodity market
Gold traded end-to-end of set near term range of 1615-1685 before close of week at 1649. Given the mild bullish undertone of the USD Index and lack of clarity on QE3, upside gains will be limited; however expectation of QE3 in the last quarter of 2012 will attract good buying interest at 1615-1600. We continue to watch short term range play at 1600-1700 with break either-way not expected to sustain. For the week, let us continue to watch consolidation at 1615-1685 with immediate bias into lower end. The strategy is to play end-to-end of this move by selling at 1670-1685 and buying at 1615-1600 with tight affordable stop.
NYMEX Gold held within the set consolidation range of 101-104 and break either-way into weekly low of 100.68 and high of 104.24 set up trading opportunity before close of week at 102.90. The undertone continues to stay neutral with no clear momentum to provide a sustainable trend into the short term. For the week, let us watch consolidation at 100-105 with bias for extended weakness into 97-95 in due course. The strategy is to trade from short side (at 104-105) for 101-100 and thereafter into 96-95.
Have a great week ahead.................................Moses Harding
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