MARKET PULSE: Weekly report for 28th May – 01 June 2012
Special Market Operations or USD Bond issuance – which is the better option?
RBI deployed strong ammunitions to dilute the momentum in rupee fall but could not prevent the “run” into 56-57 (low of 56.39). This is seen as strong support zone for rupee where genuine dollar supplies will come in and would hurt importers to acquire dollars at such high rate; August 2012 dollars above 57.25 and 12M dollars above 60.00 is not a bad hedge for exporters to lock in higher export realisation. The pain (for importers) and gain (for exporters) will shift the forward market into supply-driven mode. This is what precisely happened (to dilute the bearish set up on rupee) and RBI’s physical intervention was effective to guide weekly close at 55.40; one rupee relief from all-time low. So, it validated our belief that rupee should be allowed to find its own floor where lumpy dollar supplies comes into the market while demand is cut. Rupee is not yet out of trouble. The concerns over structural issues stay valid. The domestic issues revolve around policy catalysis and fiscal consolidation. There is no hope at this stage that UPA Government has the power to open up the flood gate to attract external liquidity and capital. There is not much optimism in removal of the fear on policy/reform paralysis. Can the Government work on fiscal consolidation? Government tested the water with petrol price hike (considered as low hanging fruit) but faced stiff resistance from within and outside UPA. The next action will be on Diesel, Kerosene and LPG but the quantum of hike may not be enough to have significant reduction in cost subsidisation. So, there are no bullish cues from domestic sector. The external sector is very fragile with threat of Greece exit from the Euro zone. The “price” that Global Economy pays to keep Euro zone intact is huge. There are no positive signs from here which carries the risk of extended rally in US Dollar against global currencies and dilution in downtrend in commodity prices. Given these factors in play, there is no guarantee that rupee weakness may not extend beyond all time low of 56.39. Rupee could fall beyond immediate support at 56.50-57.00 if USD Index extends it rally beyond 82.60-83.10 resistance zone into 85.25-85.50, pushing EUR/USD into 1.22-1.18. These market developments can put rupee at risk for deeper fall into 58.25-58.75 ahead of 59.50-60.00. RBI should stay prepared to arrest this move.
RBI has two options to guide the rupee back to its realistic value: one, to open up special dollar counter for Oil PSUs and large ticket dollar demand (FCCB/ECB repayments) from other companies. It is fair to provide access to this counter for everyone and not restrict to PSU entities alone. What will be the impact? While RBI may provide dollars on spot delivery basis, it will open up huge demand in the forward market with spot dollar being sold at subsidised rate. The resultant high FX premium will exert upward pressure in MM rates. The “lead” of 3-6M import will generate additional dollar demand of minimum $50 Bio in spot market exclusive of oil PSUs. This can also trigger FII’s exit from debt/equity capital market at subsidised dollar rate. The benefit from this “operation” can provide stability in rupee at 54-55 if RBI is comfortable to run down its dollar currency reserves to USD 200 Billion. The cost of this operation will be huge depletion in RBI’s USD reserves; spike in LAF draw-down to Rs.1.5-2.0 Trillion and the need to provide rupee liquidity through aggressive CRR cut and OMO bond purchases. The end result is that of shift of dollar asset to rupee asset in RBI’s Balance sheet. The cost-benefit seems to be not in favour. The other option is the issuance of sovereign USD bond to NRIs and other eligible foreign investors who have access to Sovereign/Corporate Bond market. The earlier issuance (RIB and IMD) were done when LIBOR was high; now LIBOR is low to keep the coupon rate much lower than the earlier issuances. The impact on RBI’ Balance sheet will be that of creating a USD liability (direct or through a PSU Bank, the bond issuer) and build up of rupee asset through OMOs. The only difference (between the two options) is that of using borrowed USD funds instead of dipping into the reserves with no fear (or risk) of creation of demand for forward dollars. The execution and operation process will be simple providing flexibility to RBI to sell dollars as and when needed...this “fear of unknown” will itself drive the USD/INR pair down to 52-53. So, it seems USD Bond issuance (with equivalent OMO) may be a better option. It will indeed send positive vibes (and great relief) into stake holders and revive investor confidence on market stability; USD/INR around 52.50, 10Y Bond yield around 8.25% and NIFTY into 5600. Isn’t a great feeling? Let us see what is in store?
Currency market
We looked for USD/INR to lose steam at 56.00-56.45 and advised exporters to sell August 2012 dollars at 57.00-57.25; rupee posted an all-time low of 56.38 (August 2012 dollars high at 57.40) and reversal from there held at the door step of support window of 55.25-54.80 (dollar low of 55.24) before close of week at 55.37. The close below 55.65 and above 55.25 is neutral with no clarity on immediate direction. The sharp reversal was triggered by all factors turning in support of rupee. USD Index held below strong resistance at 82.50-82.60; EUR/USD rallied from 1.2495 to 1.2602; RBI’s aggressive dollar sale was effective when dollar bulls were weak and attractive forward dollar pulled in dollar supplies in the forward market. What next? Rupee seems to have formed a strong support at 56.35-56.50 and should stay protected (by RBI) to avoid reinstatement of bearish set up on rupee. On the other hand, till measures are taken to address structural woes it is difficult for rupee to sustain its gains beyond 54.80 (ahead of crucial 54.30). The effort of the Government to cut fuel cost subsidisation provides good comfort. On the assumption that domestic cues will turn neutral in the near/short term, developments in the Euro zone and its impact on USD will be seen as critical to provide directional guidance from now on. Rupee will be at risk if USD Index rallies beyond 82.50 into 85.25-85.50 (and EUR/USD into 1.22-1.18). This will drive rupee beyond 56.38 into 58.25-58.75 and thereafter into 59.50-60.00. Let us consider this as very low probability but keep this in back of our mind. For the week, let us watch consolidation at 55.25-55.95 with overshoot limited to 54.80-56.40. The strategy for importers is to buy 1-2M forward dollars at value below 55 absorbing rupee strength into 54.80-54.30. On the other side, it is good to sell 3M forward dollars at value above 57.00 and 12M forward dollars around 59.50 absorbing dollar strength into 55.95-56.40. Fleet footed traders need to be very alert tracking USD Index; EUR/USD and of course, keeping eyes and ears on RBI. The art of trading this market is to know the trick of “wind surfing” (to wait for the right/big wave to ride and exit before getting consumed by another big wave) and “fishing” (to stay in patience till the market trades close to either end of the set ranges); setting up trades with very low risk but with huge reward in ratio of minimum 1:5. It is better not to be a “boxer” in this volatile market, the chances of getting hurt are more and the punches that hit the target may be few.
EUR/USD held well at the strong support zone of 1.2525-1.2475 (low of 1.2495) and recovery from there lost steam at strong resistance zone of 1.2600-1.2625 (high of 1.2619); nevertheless it provided good two-way moves for fleet-footed traders. The inability to take out 1.2625 and weekly close at the support zone (1.2515) is neutral to bearish for the Euro. For the week, let us watch 1.2250-1.2625 with bias into lower end while 1.2625 stays firm; if broken can extend to 1.2775-1.2825 before down. The strategy is to stay “short” with stop/reverse at 1.2625 for test/break of 1.2475-1.2485 which would get the near term focus into 1.20-1.18 in due course.
USD/JPY was in consolidation mode at 79-80 (high of 80.07 and low of 79.20) before close of week at 79.65; as expected gains above 80 could not sustain but did not have the momentum for extension into next target at 78.25. For the week, let us watch 78.25-80.50 with bias into lower end. The strategy is to stay “short” at 80.00-80.50 (with stop at 80.75) for 78.25-77.75. Beyond there, the focus will be on 76.00-75.50 before strong reversal.
We had set EUR/JPY near term target at 102-97 and looked for quick move below 100 into the lower end; as expected reversal from high of 102.12 was sharp to post a low of 99.33 and bounce from there held at immediate resistance at 100.50 (100.32) before close of week at 99.75. Given the weak undertone both in Euro (against USD) and USD (against JPY), the downward pressure is severe on EUR/JPY currency pair. For the week, let us watch 97.00-100.50 with bias into lower end; the pressure is clearly on move below 97 while any upside attempts fail at 102. The strategy is to stay “short” with stop above 100.50 for 97.00-97.25. If stopped sell again at 101.75-102.25 with stop above 102.50.
Interest rate market
Money Market continues to stay tight with LAF draw drawn around Rs.1 Trillion and overnight MIBOR around 8.25%. The FX impact has pushed 3-12M CD rates into 9.75-10.0%; sharply up from recent low of 9.25-9.5% despite delivery of 50 bps rate cut. 1Y Bond yield is also up from 8.20% to 8.35% while 1Y OIS rate up from 7.95% to 8.05-8.10%. What next? Let us look for stability at current levels till RBI continues to release rupee funds to off-set FX impact on MM. For the week, the draw down from LAF will stay below Rs.1 Trillion on lower demand on move into end of reporting fortnight with overnight MIBOR at 8.15-8.25%. Let us watch 1Y Bond yield at 8.25-8.35% and 1Y OIS rate at 7.95-8.05% and test/break either-way not expected to sustain. The strategy is to stay invested in 1Y Bond (and hold as excess SLR); it will be useful when we get into churning of investment book on sharp rally in long bonds.
10Y Bond yield traded end-to-end of set weekly range of 8.47-8.58% before close of week at 8.51% while 5Y OIS nicely edged up from lower end to higher end of 7.40-7.50% before close of week at 7.50%. The stability in Bond market is thanks to weakness in FX market as RBI is expected to conduct its OMOs. Given the strong bearish set up on rupee, RBI is expected to provide dollar supplies in FX market for extended period of time. This also puts off rate cut expectations and more CRR cuts ahead. The directional break-out beyond 8.45-8.60% will be on rupee getting back its strength into its fair value (for push into 8.75%) and issuance of USD Bonds (for sharp rally into 8.30%). 5Y OIS is expected to maintain its 100-105 bps spread (with 10Y bond yield) for consolidation at 7.40-7.55%. For the week, let us watch 10Y Bond yield at 8.45-8.55% and 5Y OIS rate at 7.45-7.55% with test/break either-way not expected to sustain. Fleet-footed traders can play end-to-end of these ranges while strategic players look stay invested in 10Y bond at 8.53-8.58%. Let us also unwind 5Y paid book (entered at 7.40%) at 7.55% with trail stop at 7.45% and look to build receive book on extension into 7.55-7.60%.
FX premium maintained its uptrend; 3M up from 6.75% to 7.1% and 12M sharply up from 4.9% to 5.5% before close of week at 7% and 5.4% respectively; but for RBI’s B/S swaps (to shift spot sales to forward date), it would have been much higher tracking interest rate play. For the week, let us watch 3M at 6.90-7.40% and 12M at 5.25-5.75% with bias into higher end. The strategy is to pay 3M at 6.90-6.75% (for cost reduction through USD sources); hold on to 12M paid entered at 5.0-4.90% and add at 5.35-5.25% with trail stop below 5.25% for 5.70-5.75%.
Equity market
NIFTY played within the set weekly range of 4775-4975 (low of 4789 and high of 4956) before close of week at 4920; thus trading end-to-end of sell zone at 4950-4975 and buy zone of 4800-4775. The moves in NIFTY more or less mirrored DJIA trading end-to-end of 12300-12600 (low of 12311 and high of 12575) before close of week at 12454. What next? There are more negative cues in play at this stage. The domestic macros are weak; rupee needs strong support from RBI to arrest extended weakness driven by strong USD and limited signs of optimism from the external sector. There is no buying appetite from domestic investors while off-shore investors are nervous keeping close watch on rupee and policy paralysis. However, there is bit of comfort from the efforts of the Government to cut fuel cost subsidisation and RBI’s open support to rupee in the form of Special Market Operations and/or Sovereign USD Bond issuance to NRIs and off-shore investors. Now, it is important that DJIA stays above strong support at 12220-12200 for relief rally into 12550/12700 to support NIFTY above 4775 for extended gains into 5075-5100. For the week, let us watch NIFTY at 4800-5100 and stay neutral on break-out direction. The strategy is to trade end-to-end by buying at 4825-4775 (with stop at 4750) and selling at 5075-5125 (with stop at 5150). The entry level for strategic investors is revised upwards to 4775/4650/4525 in three lots with stop below 4500 for 5600.
Commodity market
Gold is firmly in consolidation mode within the set near term range of 1520-1620; initial rally from 1527 lost steam at 1599 before sharp reversal to 1533 bouncing back again for weekly close at 1573. The strategy to buy dips into 1535-1525 (with stop below 1520) for move into 1600-1620 has worked well. What next? There are good signs of build up of momentum for extended rally above 1620 into 1670 for 100% reversal of fall from 1671 to 1527; resistances on the way at 1599/1616/1640 while reversal below 1550 (into 1530) stays firm. For the week, let us watch consolidation at 1535-1615 with test/break either-way to attract. The strategy is to trade end-to-end by buying at 1550-1535 (with stop below 1525) and selling at 1600-1615 (with stop above 1625).
NYMEX crude could not sustain its move above 93 (upper end of set 88-93 range) and fell sharply from high of 93.06 to 89.28 before close of week at 90.86. The downtrend in NYMEX crude is firmly in place till recovery in global economy is sighted and the bigger comfort is from G3/OPEC support to arrest rally through increase of supplies into the market. The tension between Iran and the West is seen to be out of the radar given other major issues on priority. For the week, let us continue to watch 83-93 with bias into lower end. Our strategy is to hold on to “shorts” entered at 110 for all the way to 75; let us hold on to this with trail stop at 95 and review the same after meeting the immediate objective at 83.50. Fleet footed traders can look to sell at 91.5-94.5 (with stop above 95) for 83.50.
Have a great week ahead.................................Moses Harding
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