MARKET PULSE: Weekly report for 15-19 October 2012
(Intra-week/day updates on Twitter handle: mosesharding)
Exchange rate stability is critical to get Indian economy out of its woes
It is good to hear from the Finance Minister that ensuring Rupee exchange rate stability will be the top agenda while the Government and RBI focus on critical issues relating to fiscal deficit, growth, inflation and Balance of Payment. It is obvious that volatile rupee exchange rate (with bearish undertone) will be a strong headwind to dilute the impact of measures taken to address macroeconomic stability. The Indian foreign exchange market is already facing current account deficit (CAD) of $15-18 Billion per month. The reason for widening CAD is largely due to higher Crude Oil and Gold Price and reduced demand for India’s goods and services from the US and Euro zones. There is nothing Indian authorities could do to resist these forces except to cut non-essential imports; build domestic capacity for essential imports and higher wallet share of exports to the Eastern World. In this context, it is important that we maintain steady inflows through Capital account from non-resident Indian community and foreign investors to bridge deficit in Current Account. It is difficult to attract sustainable off-shore inflows without exchange rate stability. If the risk on exchange rate is seen to be higher than the interest rate differential or expected return on the underlying asset, no prudent foreign investor will look at India, and without surplus Balance of Payment, rupee will get into bearish undertone. When Rupee gets into bearish undertone, the impact from forward market comes into play. Exporters will hold-back dollar receivables while importers front-load future dollar payables into the spot market. The resultant “run” on Rupee can be very severe to hurt macroeconomic fundamentals. How? A weak Rupee exchange rate is inflationary and exerts upward pressure on interest rates while borrowers tend to borrow in rupees to cause liquidity strain on the system. On the other hand, tight liquidity and high interest rates will cut domestic savings and investments. In the absence of investments from both external and domestic sector, supply side bottlenecks will trigger inflationary pressures. These factors will obviously exert downward pressure on growth momentum. Such is the strong bonding of exchange rate with growth-inflation dynamics; and without higher growth momentum, it is impossible to cut fiscal deficit or have deep pockets to support the vote bank. In the current Indian context, there is need to drive headline inflation down to shift monetary policy to be enabler for growth; and strong rupee is the immediate solution which will result in cut in subsidy without effecting price hike.
Rightly so, Government and RBI have done lots to attract NRI flows and to open up Indian debt and capital market to off-shore investors. The objective is to ensure sustainable flows into Capital account till Current account is turned into neutral. In the longer term, it is important that we turn surplus in Current Account to stop export of capital from India through trade deficit. If the Indian system gets into low inflation and surplus current account mode, it will be easy for the Central Bank to manage excessive moves in exchange rate. RBI could do very little when rupee fell by over 30% (from 43.85 to 57.32) in less than a year. RBI did not have enough dollar resources in its balance sheet or enough money in the domestic system. Now, it is difficult for RBI to arrest excessive rupee gains when the need is to maintain deficit system liquidity till inflationary fears are completely out of the way. Government has shifted into higher gears to maintain surplus Balance of Payment through pulling off-shore flows into Capital account till CAD issues are resolved. It is the first step towards ensuring exchange Rate stability. There are series of measures towards fiscal deficit control and removal of supply side bottlenecks through capacity expansion in core sectors. These measures are towards inflation control to enable shift into pro-growth monetary stance. A combination of favourable political and monetary dynamics is essential to get into robust macroeconomic dynamics. The immediate impact of current (and pipe-line) measures would only lead to change in sentiment and perception. While trending into set economic objectives will be visible in the short term, realisation of tangible results at the ground level will extend into medium/long term. Till then, it is important to keep strong headwinds away. A weak rupee at this stage is definitely a very strong headwind and therefore, Rupee has to get into bullish undertone to stay as catalyst to the efforts taken by the Government. On the other hand, confirmation of bullish undertone on rupee will front-load dollar supplies (from future receivables) into spot market for RBI to shore up its dollar balance sheet and release rupee liquidity in the system. The resultant ease of pressure on liquidity and interest rates will spur growth and pull in domestic savings and investments. RBI is seen to appreciate the pressure on growth while having greater comfort on easing of inflation in the short/medium term. The threat of rating downgrade is still in the air. It is the right time to send confidence boosters on rupee exchange rate to pull inflows from external sector; bring lead-lag factor into play in the forward market and provide comfort to borrowers to shift rupee liability into foreign currency of their choice. The current vicious cycle concerning conflict in play between growth-inflation dynamics and its adverse impact on fiscal deficit and growth has to be broken with bullish undertone on rupee exchange rate.
Currency market
Rupee unwound its strong gains since second week of September from 56.03 to 51.35. The unwinding process extended to 53.18 before close of week at 52.81 against previous week close of 51.85. The reversal in rupee fortunes from recent low of 57.32 into 51.35 did surprise many; if not the directional trend, the speed of recovery was indeed a surprise to all. Hence, the reversal from 51.35 to 53.18 is seen to be in order and may be seen as good for exporters to hedge uncovered future dollar receivables. Now, there is debate; whether the move from 51.35 to 53.18 is a counter-trend move as correction process (of the bull move from 57.32 to 51.35) or reversal of very short rupee bullish trend back into earlier bearish phase (from 48.60 to 57.32). For reasons discussed above, MARKET PULSE considers this move as a correction process, hence recommended (in the intra-week update) not to chase rupee weakness into 53.00-53.25. Spot rupee at above 53 and Rs.3 premium for 12M dollars is too good to ignore. What next? Rupee is seen to have settled into short term range play at 50.25-53.25 and expected to get into consolidation mode at 50-51 by end of 2012. Beyond there, if implementation of reforms is executed well to improve macroeconomic fundamentals, rupee could get into 48-51 consolidation in January-March 2013. The risk factor to this expectation is obviously political; inability of the UPA Government to get Parliamentary approval on bills cleared by the Cabinet and lack of political support for follow-on economic/financial reforms. At this stage, possible delay in RBI’s shift into pro-growth monetary policy stance is not seen as risk. The political risk to drive rupee into bearish undertone is seen low, hence bullish expectation on rupee. The next couple of weeks will be a period of consolidation within 52.20-52.90; extension limited to 51.90-53.20. The strategy is straight-forward; to cover 6-12M exports at 52.90-53.20 and await 52.20-51.90 to cover 1-3M imports.
It is mixed signals in G3 currencies. Bond and Equity markets are in sideways trading mode with no directional clarity. Investors are unable to take a clear view on the risk; aggressive players are seen to stay risk-on while conservative investors continue to stay in risk-off mode. USD Index is in consolidation mode at 79.40-80.20 and EUR/USD at 1.2825-1.3050. This has been a nice trading range for traders; weekly close at 79.60 and 1.2950 is bearish for the dollar. For now, EUR/USD is likely to get into consolidation mode at 1.2875-1.3075 with initial bias into higher end; failure around 1.3075 will be negative for the Euro for strong correction below 1.2875 into 1.2825, thus bringing the focus into 1.2750-1.2700. On the other hand, decisive break of 1.3075 will trigger a quick move into 1.3175 and bring the focus into 1.3475-1.3550. This will complete end-to-end move of set short term range of 1.20-1.35. The failure of USD Index above 80 adds credence to strong Euro in the immediate term to drive USD index below 79.60-79.40 support for consolidation at 78.60-79.10. The strategy therefore is to buy Euro on dips into 1.2925-1.2850 for 1.3075-1.3175.
USD/JPY traded end-to-end of 78.00-78.75 range with weekly close at 78.45; inability to take out 78.60-78.75 for 79.25 is concern and more the delay, chances of extension into 77.40-77.15 will come into play. For now, let us continue to watch 78.00-78.75 and stay neutral on break-out direction. The strategy is to trade end-to-end with tight stop while strategic players could stay aside for either 77.40-77.15 or 79.00-79.25 to initiate action.
Interest rate market
It was steady undertone in Bond/OIS market. 10Y Bond found good support above 8.17% while weekly auctions resisted gains below 8.15%. OIS rates nicely traded end-to-end of 7.55-7.62% (1Y) and 6.95-7.02% (5Y). What next? Money market conditions have turned favourable; average liquidity deficit for the reporting fortnight is down below 1% of NDTL; 3-12M rate curve is sharply down and 91-182D T-Bill cut of yield is at 8.10%. There are also signs of role change between the Government and RBI. Government is now seen addressing issues related to inflation and it is expected from RBI to turn pro-growth. It is in order for RBI to shift operative policy rate to minimum 7.75% when 182 days T-Bill yield is at 8.10%; almost flat at overnight call money rate. As said before, RBI may need to deliver either 50-75 bps CRR cut or 25 bps rate cut to drive operative policy rate below 8%. The recent economic data of headline CPI and IP are into favourable trending for RBI to act on policy rate instead of cosmetic 25 bps CRR cut. MARKET PULSE already initiated buy recommendations in 10Y Bond yield above 8.17% and receive OIS at 7.62% in 1Y and 7.02% in 5Y on expectation of 25 bps rate cut on 30th October. RBI has the option to maintain deficit system liquidity below 1% of NDTL through OMO Bond purchases in Money Market and dollar purchases in the FX market. For now, let us watch 10Y Bond yield at 8.12-8.17%; 1Y OIS at 7.55-7.62% and 5Y OIS at 6.95-7.02% with bias into lower end. The near term objective post monetary policy is at 7.95%; 7.45% and 6.90% respectively. The strategy is to hold on to “longs” entered at/above 8.17% (10Y Bond); 7.62% (1Y OIS) and 7.02% (5Y OIS) and add at 8.17-8.20%; 7.62-7.65% and 7.02-7.05% respectively for the set near term objectives.
Equity market
It was period of profit-booking driving NIFTY from below set near term objective at 5830 (high of 5815) to strong short term support at 5630 (low of 5637) before close of week at 5676. This 200 point correction (as counter trend move) is seen as good post 1000 point rally from 4770 since first week of June. FII flows which drove the market up from 5200 post QE3 and domestic reforms are seen to be in wait-and-watch mode till current correction process is out of the way. It would need combination of off-shore and domestic investors to drive NIFTY above 5830 into set short term target at 6330. The major trigger for this move will be on Parliamentary approval, rate cut from RBI and confirmation of rupee bullish trend into 50-51. The risk factor for move below 5630-5580 is from inability of UPA to get Parliamentary approval on reform bills cleared by the cabinet; failure there is seen as very low risk at this stage. Let us now watch strong short term support zone at 5660-5580 and near term resistance at 5750-5830. The strategy is to hold on to “longs” entered at 5660-5630 and add at 5610-5580 if seen for near term objective at 5800-5830. Beyond there, RBI’s shift into growth supportive monetary stance and dilution in sovereign rating downgrade risk will trigger extended gains beyond 5830 into 5950/6175/6325.
Commodity market
Gold is boxed within set near term support at 1750-1765 (low of 1752) and resistance at 1790-1805 (high of 1795) for close around 1770. The consolidation in USD Index at 79.40-80.20 is holding Gold within the set support and resistance zones providing good two-way trading opportunity. What next? The directional bias for USD Index is for test/break below 79.40 for 79.10-78.60. This will set up bullish bias in Gold for 1790-1805 but would need weak dollar below 78.60 to drive Gold into short term target at 1835-1860 ahead of September 2011 high of 1920. On the other hand, if investor risk-aversion drives USD Index above 80.20 into 80.70, Gold will get into extended correction phase into 1730. For now, let us watch consolidation at 1750-1800; test/break either-way is not expected to sustain. Strategic investors can absorb extended correction into 1730 with tight affordable stop for 200 dollar rally into 1920.
NYMEX Crude continues to stay in consolidation mode within the now familiar 88.50-93.50 range (low of 88.21 and high of 93.66) before close below 92.00. NYMEX crude is seen to have already hit a medium/long term “top” at 100.42 (post QE3 high on 14th September) and in the process of unwinding its rally from 77.28 to 100.42. The expected rally post QE3 has not materialised. The bearish expectation on early turnaround in Global economic growth and indigenous production of alternate fuel by most countries dependent on imported fuel will cut demand-push support for the crude. If USD Index can hold on to its short term support at 78.60, there are no factors to turn bullish on Crude. The short/medium term bias is therefore for gradual reversal below near term support at 87.50-86.50 ahead of 83.50. For now, let us continue to watch consolidation at 88.50-93.50 with bias into 87.00. It is a good risk-reward for strategic investors to stay “short” in NYMEX Crude in two lots at 93-94 and 99-100 with stop above 101 for 78-83.
Have a great week ahead..........................................Moses Harding
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