Weekly report for 21-25 May 2012

     MARKET PULSE: Weekly report for 21-25 May 2012

Currency market

Rupee hit an all-time intra-day low of 54.91 but managed to close sharply lower at 54.43. In the meanwhile USD Index met its first objective at 81.75 and reversed sharply to 81.02 driven by EUR/USD rally from 1.2640 to 1.28. This validates our stance that rupee weakness is driven by strong dollar against global currencies and it would need unwinding of dollar strength to provide relief to rupee while RBI’s actions could only limit excessive traction between USD Index and USD/INR. What next? We have discussed enough of macro issues (political, economic and monetary) and huge uncovered dollar liability exposures in the system; in the absence of adequate inflows into capital account and bearish outlook on the economy, the forward market is firmly into demand-driven mode. With all these strong headwinds, RBI could not prevent rupee from posting new all-time low above 54.30. Rupee bulls should wish and pray for USD Index losing steam at 81.75-82.50 to protect rupee at 55.25; if not, it will open up steady weakness into 57. Now immediate support to watch in USD Index is at 80.50 which could drive rupee into 54.10 and further extension into recent low at 79.50 would extend rupee gains into 53.50; lower end of set near term range of 53.50-55.50. For the week, let us watch 53.50-55.00 and keep close watch on USD Index (and EUR/USD) for directional guidance. The expectation is that of USD Index holding its strong ground above 80.50 to get the focus back into 81.75 during the course of the week. Given this expectation, USD/INR should form a base somewhere between 54.10-53.50. It may be prudent for importers to cover 1-3M imports at forward value below 54.50, gradually absorbing spot gains from 54.10 to 53.50. Exporters who sold 3M dollars at 55.00-55.20 can look to exit below 54.50 (net of “carry” for the time decay).

EUR/USD met the first objective at 1.2625 (low of 1.2640) but expected “correction” from there into 1.28-1.29 (high of 1.2794) was sharp and driven by strong buying in Euro crosses and “short squeeze” ahead of weekend. What next? The trend for the EUR/USD is bearish and this sharp 150 pip correction may not be seen as trend reversal; having fallen sharply from 1.3283 since 1^st May 2012. There is no change in view of looking for test/break of strong support zone at 1.2625-1.2550 into 1.22-1.19 into the short term. The risk factor to this expectation is on EUR/USD break above strong resistance at 1.2850 which will then open up 1.3000; considered as low probability occurrence at this stage. For the week, let us watch 1.2625-1.2875 with bias into lower end, not ruling out extended weakness into 1.2550-1.2475. The strategy is to sell in two lots at 1.2825 and 1.2875 (with stop above 1.2900) for 1.2650-1.2625.

USD/JPY is firmly into its downtrend having posted a low of 78.97 despite strong 100 pip rally in EUR/JPY from 100.20. The risk of extended weakness in USD/JPY into 76.00-75.50 is opened up now for 100% reversal of its move from 75 to 85. For the week, let us watch 78.00-79.50 with bias into the lower end. The strategy is to stay short with stop above 79.50 for 78.10. EUR/JPY met its first objective at 100 (low of 100.17) on clear break below 102.50. Now, any cross inspired rally has to fail below 102 to retain its bearishness for extension into 97.00. For the week, let us watch 97-102 with bias into lower end. The strategy is to stay “short” with stop above 102 for 97.25.    

Interest rate market

Money Market is tight and facing severe liquidity squeeze on aggressive dollar sales by RBI and release of cash through OMO is not sufficient. RBI cannot afford to release cash through B/S swaps (or sale of outright forward dollars) as lower premium will increase demand for dollars in the forward market. The bearish sentiment is reflected in the rate curve with 3-12M rate curve sharply up at 10%. The 3M rate has moved up from 9.25% to 10% despite 50 bps rate cut; this is serious concern of the stake holders and highlights lack of optimism into the future with limited bandwidth to deliver rate cut in the short term. The positive take-away is that of possible delivery of 50-75 bps CRR cut ahead of advance tax outflows in mid June. For the week, higher demand for funds into first week of new reporting fortnight would keep drawdown from LAF at over Rs.1.25 Trillion and overnight MIBOR at higher end of 8.15-8.40% range. 1Y Bond yield is expected to stay steady at 8.30-8.40% with good demand from Banks to cut duration of bond portfolio without much compromise on the yield. 1Y OIS rate is down to lower end of 7.95-8.10% short term range and would not prefer test/break of lower end with bias into 8.05-8.10%. For the week, let us watch 7.95-8.05%; suggest not to stay received below 7.95%; considered good hedge against call borrowing book and 1Y Bond investment portfolio.

10Y Bond yield is in consolidation mode at 8.45-8.55%; OMOs driving the yield to 8.47% for sharp reversal from there to 8.54% ahead of Bond auction before close of week at 8.53%. It is obvious that RBI need to conduct its OMO on a regular basis to prevent weakness into 8.60-8.65% and beyond. So, Bond rally into 8.45-8.35% is subject to rupee staying under pressure for extended weakness into 56-57; else 8.65-8.75% comes into the radar. The stake holders will have close watch on core inflation and manufacturing data but the expectation on the way forward is that of release of liquidity through CRR cut (from current 4.75% to 3% through FY13). The next round of rate cut is not expected before July-September 2012. Let us stay with our short term range of 8.45-8.60% with extension limited to 8.35%-8.70%. 5Y OIS slipped below 7.40% (low of 7.39%) before close of week at 7.43%; Bond-swap spread is up from 100 bps to 110 bps. There are no strong cues to expect sustainability in 5Y OIS rate below 7.45-7.40% with risk of bounce back to 8.60-8.65% in due course. For the week, let us watch consolidation in 10Y Bond yield at 8.47-8.58% and 5Y OIS rate at 7.40-7.50% and test/break either-way not expected to sustain. The strategy is to play end-to-end by buying at 8.57-8.59% and selling at 8.48-8.46% with tight stop. It is not a good risk-reward to stay “received” in 5Y OIS below 7.40% (incurring 80-100 bps negative “carry”).

FX premium nicely held at strong support at 6.75% (3M) and 4.90% (12M) and reversed sharply for close of week at 7.05% and 5.3% respectively; the strategy to stay paid in 12M at 5.0-4.90% has worked well. Now, we will allow for test of immediate resistance at 7.25% (3M) at 5.40% (12M) and watch exchange rate play for next direction. Having said this, interest rate play will continue to exert upward pressure on move into lower end. For the week, let us watch consolidation in 3M at 6.90-7.40% and 12M at 5.0-5.40%. Hold on to “paid book” in 12M with trail stop at 5.0% for 5.60-5.70%. For others, look to initiate pay in 12M at 5.15-5.05% (with stop below 5%) for the set target. The high 3M rupee interest rate and demand for 3M dollars will not allow sustainability in 3M premium below 6.75%; not to miss this if seen for spike into/above 7.5%.   

Equity market

It was volatile week in NIFTY; held well at the resistance/sell zone of 4950-4975 (high of 4957) for sharp reversal into set target at 4825-4775 (low of 4788); followed by sharp rally into 4908 before close of week at 4891. Over all, it’s back-and-forth move between set sell zone at 4925-4975 and buy zone at 4825-4775 with no strong momentum to provide range break-out. The weekly close above 4850 and below 4925 is neutral and mixed. In the meanwhile DJIA fell sharply from weekly high of 12818 into set objective at 12220-12200 (low of 12336) before close of week at 12369. What next? The trend is bearish; there are no strong positive cues from either domestic or external sector to get the market into bullish mode. The domestic factors continue to weigh heavily against equity assets and it would be extremely difficult for RBI to maintain its pro-growth monetary stance and deliver rate cuts. It is less said the better about domestic liquidity and cost of funds; money market is facing the brunt of heat from actions in FX market. There seems to be endless flow of negative news from the Euro zone. The economic data from the US is also not encouraging and the expectation of stimulus support is strong. In short, the strength of equity asset market is not based on strong fundamentals or optimism into the future but the extent of liquidity support from Central Banks and economic stimulus packages being rolled out by the Governments. This scenario is not good for equity market into short/medium term; at best it could set up good trading opportunity for fleet footed traders while strategic investors get into wait-and-watch mode and stay invested in debt/fixed income assets. The investors are clearly on “risk-off” mode and it is negative that shift into “risk-on” mode is short-lived. Now, it is important for DJIA to hold above strong support at 12220-12200 to arrest extended weakness in NIFTY below 4825-4775 support zone; else December 2011 low of 4531 will come into play tracking extended weakness in DJIA into 11875. For the week, let us watch consolidation at 4775-4950 and stay neutral on break-out direction which then can extend to 5075 or 4650, first entry point for strategic investors. MARKET PULSE is bearish till entry into 4650-4350 considered good to enter for strategic investors in three lots at 4650/4500/4350. The strategy for fleet-footed traders is to sell at 4950-4975 with tight stop; if stopped sell again at 5075-5100 (with stop above 5125). On the other side, buy at 4775-4750 with tight stop; if stopped buy again at 4650-4625 (with stop below 4600). Over all, short term trading range is at 4500-5000; test/break either-way will not sustain.

Commodity market

It was volatile week for Gold; fell sharply from 1585 to 1527 and back again to 1597 before close of week at 1591. Over all, the strategy to stay “short” for 1525 worked well but sharp rally from there into higher end of set weekly range of 1520-1620 was surprise. It is obvious that move into 1525 attracted huge “short covering” to capture the 14% fall (from 1790) since first week of March 2012 and development of Greece exit out of the Euro zone generated relief rally in Gold. The strong rally in USD in recent times brought the shift to Gold as alternate to USD. What next? Given the extended rally in USD and very low sovereign yields, there is investor appetite for Gold on expectation of QE3 linked rally. We also anticipated a sharp reversal and identified 1495-1480 as the buy zone to catch this rally. It is now possible that the rally has begun targeting the strong resistance zone of 1625-1640 while support at 1560 stays firm. For the week, let us watch consolidation at 1560-1640 not ruling out 100% retracement of recent fall from 1671-1527. The strategy is to stay cautious buyer on dips into 1560-1535 (with stop below 1525) for 1655-1670.

NYMEX Crude maintained its downtrend from weekly high of 95.83 to 90.93 before close of week at 91.48; strategy to stay “short” for this move worked well. What next? The “gloom” in the global economy and sharp rally in USD Index has brought the market into bearish trend; 17% reversal since 1^st March 2012 high of 110.55 will significantly cut (excess) liquidity driven inflationary pressures on the global economy and provide comfort to maintain loose monetary policy to spur growth. Unfortunately, India lost its advantage with 25% depreciation in rupee from below 44 to 55 since July 2011 and 12% fall from 48.60 since February 2012.  For the week, let us watch 83-93 with bias into lower end. The strategy is to hold “shorts” with trail stop above 93 for 83.50. For others, look to sell at 94-96 with tight stop. There are no strong cues to look for reversal of current bearish trend above 95 with short term target at 75 (and BRENT Crude around 90).

Have a great week ahead........................Moses Harding