MARKET PULSE: Weekly report for 22-26 October 2012
Conflicts in play for FM and RBI to walk in the same direction
The guidance from Finance Ministry (to RBI) is loud and clear for low interest rate regime, surplus system liquidity and strong rupee. Obviously, these are minimum essentials to attract domestic and foreign investments for capacity expansion and increase domestic consumption to achieve set budgetary goals on growth and fiscal deficit. The monetary dynamics are otherwise with deficit system liquidity of more than 1% of NDTL, high interest rates with overnight rate at higher end of LAF corridor and sudden bearish set up on rupee down by over 5% from recent high of 51.35 to 54.00. It is also obvious that resolutions to supply side constraints and high fiscal deficit are essential to guide headline inflation into set target. The conflicts in play between growth and inflation dynamics are seen to get stronger (despite downtrend in BRENT Crude and Gold prices) and unless the system comes out of this vicious cycle, it may be difficult for RBI to follow FM in the same direction. The confidence post roll-out of reforms in mid September is on the decline. It is true that there is political intent to get the economy out of its woes but there is serious doubt on implementation and execution. The time to delivery between clearance of reform bills by the cabinet and approval in the winter session of the Parliament has pushed the market into bearish set up unwinding recent gains, and Rupee has been the worst performer despite weak undertone of the dollar against global currencies.
The major hurdle ahead is the political risk. Can the UPA manage support from Opposition parties for implementation of the reforms? If this is not done, sovereign rating downgrade will be matter of time citing policy paralysis and resultant limited band-width to address issues related to growth and fiscal consolidation. It will be disaster for the Indian economy and its asset markets which will lead into a medium/long term economic crisis. As a patriotic Indian, there is need to believe that good sense will prevail to avoid this kind of calamity on the Indian economy. Having said these, road map for addressing issues raised by Global rating agencies will be an extended one, but the comfort is that the journey has begun which would result in improvement in rating outlook from negative to stable. There will be hope that if the momentum of the journey can be maintained; there is good possibility of rating upgrade during the course of FY14. RBI’s immediate concern may be on the political risk. RBI continues to stay focussed on elevated inflation and resultant low real interest rates. It is felt that current low real interest rate is not seen as risk to growth and that higher inflation is not due to demand-push but from supply-side bottlenecks. On the other hand, Government is keen to have accommodative monetary policy and strong rupee exchange rate to spur growth, control inflation and attract foreign investments. The other stake holders of the system are in wait to get resolution to these conflicts between FM and RBI as both walking in the same direction is essential to get the Indian economy out of its woes and remove the fear of sovereign rating downgrade. There is no alternate option at this stage and the best (and only) option would be for RBI to address issues related to growth while FM work overtime to address issues related to twin deficits and inflation. There is immediate need for role-change to walk in the same direction!
Interest rate market is already in bullish undertone in expectation of dovish monetary policy stance. Despite elevated overnight interest rate above 8%, 182 days T-Bill yield is below 8.10% and 10Y Bond yield below 8.15%. The expectation therefore is for sharp fall in overnight rate from current above 8% into 7% during the course of rest of FY13. The deficit system liquidity at the end of fortnightly reporting cycle is at 1.5% of NDTL, thus making it difficult to push overnight rate below 8% through infusion of liquidity. In the last couple of days, RBI’s action to defend rupee has caused further squeeze in the system liquidity. The expectation of CRR cut on 30th October is high and the debate is on 25 or 50 bps. But, this action of CRR cut is not going to change interest rate dynamics; overnight rate will continue to stay above 8%. There will be “pressure” on RBI to cut rates by minimum 25 bps to signal actual shift into dovish monetary policy stance by significant ease in the shorter end of the rate curve. Can RBI cut interest rate when rupee is under pressure? This is the new dimension to the story, of late. The reversal in rupee fortunes from 51.35 into 54.00 is threatening to revert into its earlier bearish trend. It may not be fair for FM to expect RBI to cut policy rates when rupee is weak. The criticality of exchange rate stability (with bullish undertone) is immense when the system is struggling with poor macroeconomic, tight monetary dynamics and high inflation. The recent underperformance of rupee against other EM currencies will be displeasure to foreign investors. Till exchange rate stability is achieved, RBI may stay hold on policy rates and instead deliver 50 bps CRR cut. If rupee gets into stability below 53 by the policy day, then there will be hope for delivery of 25 bps rate cut.
Currency market
The initial intra-week recovery in rupee from 53.15 to 52.65 (met with strong demand to buy up to 1M dollar at forward value below 52.90) could not sustain for sharp reversal into 53.98 before close of week at 53.85. Such a sharp fall in rupee despite weak dollar (USD Index down from 80.20 to 78.95) exposed rupee’s vulnerability to bunched up dollar demand from PSU entities and the resultant hold back of dollar supplies by private entities. The lead-lag play between dollar demand and supply pushed rupee beyond strong support at 53.30-53.60 into 54.00-54.30. RBI did try to prevent this “run” on rupee but could do very little when domestic system is short of rupees and limited dollars in RBI’s balance sheet. While it is easy for RBI to arrest excessive rupee appreciation, it will be very difficult to defend excessive rupee weakness. RBI will be in a better position to defend rupee only when the system gets into surplus mode in Current account and low inflation, resolution to these structural issues is a long-drawn process. What next? The immediate support for rupee is at 54.25-54.35 followed by 54.95-55.05. The market seems to be in strong dollar demand driven mode with no bunched up supplies in pipe-line. The supplies in forward market are cut on extended rupee weakness beyond 53.60 and it will be worse on above 54.30. The global cues are turning dollar positive. Global investors are seen to get into risk-off mode on weak bond, equity and commodity assets. A strong USD Index back into 80.20 and bunched up dollar demand on a short week (with only 3 trading days) will keep rupee in bearish undertone into the week. The immediate resistance for rupee is at 53.70-53.60 (earlier support) ahead of 53.15-53.00. For the week, let us watch 53.60-54.30 and stay neutral on break-out direction into either 53 or 55. It would need strong arm tactics and confidence boosters from the Government to push rupee into 53.00-52.50 to get RBI into rate cut mode. Intra-week review and hedging/trading views will be uploaded on the blog and twitter.
EUR/USD held well at set strong support at 1.2825-1.2800 (USD Index at 80.10-80.20) for rally into set weekly objective at 1.3075-1.3175 (high at 1.3139). The expected intra-week reversal from below 1.3155-1.3170 found support at 1.3015-1.2890 (low of 1.3011). What next? USD is seen to be out of its recent bearish mode on low investor appetite. Gold is also seen to have lost its shine shifting the safe-haven to the US Dollar. It is important for EUR/USD to hold above 1.2985-1.2950 to retain its immediate term bullish mode; else deeper correction into 1.2825 will come into play not ruling out extended run into 1.2725-1.2700 before strong reversal into 1.3170. USD Index has held below 79.70 but risk in the immediate term is for extended gains into 80.20-80.70. Intra-week trade ideas will be uploaded on the blog and twitter.
USD/JPY held well above 78.25-78.00 for sharp rally above 79.25. This pair is seen to get into consolidation mode post the recent sharp rally from 77.40 to 79.45. The rally in USD Index above 79.70 into 80.20 will provide consolidation play in USD/JPY at 78.50-79.50. The near term undertone however is bullish for extended gains above 80 into 80.50-80.75. The strategy is to buy in two lots at 79.00 and 78.75 with stop below 78.50; watch price action at 79.50-79.65 for extended bull-run above 80.
Interest rate market
Bond/OIS market traded to the script and stayed bullish into the week; 10Y Bond yield down from above 8.17% to 8.12%; 1Y OIS rate down from above 7.62% to 7.58% and 5Y OIS rate down from above 7.02% to 6.96%. It was to traders delight trading end-to-end of 8.17-8.12%, 7.02-6.95% and 7.62-7.55%. What next? The draw-down from LAF counter at 1.5% of NDTL on reporting Friday has triggered expectation of OMO bond purchases by RBI. On the other hand, strong bearish set up on rupee has diluted rate cut expectation on 30th October but higher than expected cut in CRR will be to Bank’s delight. Short term rates are already down in anticipation of shift into growth-supportive monetary stance and 50 bps CRR cut will exert downward pressure on lending rates. The impact on Bond/OIS market will be neutral but near/short term bullish undertone is strong. For the week, let us watch tight consolidation at 8.10-8.17% (10Y Bond); 7.57-7.65% (1Y OIS) and 6.95-7.05% (5Y OIS). Let us reinstate “long” bonds at 8.15-8.17% and received book in 5Y OIS at 7.02-7.05%. The draw-down from LAF counter at start of new reporting fortnight is expected to be high at Rs.1.0-1.5 Trillion; hence the initial bias will be into higher end of set ranges.
FX premium sharply down for weekly close at 6.25% (3M) and 5.40% (12M) from recent high of 7.15% and 6.1% respectively. Our strategy to stay received in Oct/Sept at 282-285 has yielded quick results; sharply down from 285 to 267. What next? Signals are mixed at this stage; interest rate play will exert upward pressure while pressure on rupee will resist up move. It will be consolidation play at 6.0-6.5% in 3M and 5.25-5.60% in 12M, test/break either-way difficult to sustain. Let us stay aside and await move into either end to initiate fresh trades; it may not be prudent to staying “received” at current levels and on dips into lower end.
Equity market
NIFTY was in tight consolidation mode at 5630-5730 before close of week at 5684. The ability to hold above strong short term base at 5630-5580 provides good comfort but there is no strong momentum to take out immediate resistance at 5730-5750. Western bourses are weak and uncertainty in domestic cues (with weak rupee) is keeping investor confidence low. The preference seems to be staying light ahead of RBI monetary policy and winter session of the Parliament. Let us continue to watch strong short term support at 5630-5580 and resistance at 5730-5750 not ruling out extension into 5800-5830 on dilution in bearish set up on rupee which would revive hope for rate cut on 30th October. The strategy remains unchanged to buy in two lots at 5660-5630 and 5610-5580 with tight stop for 5800-5830.
Commodity market
NYMEX Crude traded back-and-forth between set resistance/sell zone at 92.50-93.50 and support/buy zone at 89.50-88.50 before close of week at 90. The undertone is bearish (unwinding its recent rally from 77.28 to 100.42) for 88.85 and 86.15. For the week, let us watch consolidation at 86.50-91.50 with test/break either-way to attract. The strategy is to sell at 91.5-92.5 for 86.5-85.5 ahead of near term objective at 82.25.
Gold lost steam ahead of 1755 resistance (high of 1753) for sharp reversal into strong near/short term support at 1720 (low of 1716) before close of week at 1720. The undertone has become weak on risk-aversion to get the focus into next support at 1675 on conclusive break below 1720; resistance at 1755 will stay safe for this move. The near term focus has now shifted to 1675-1660. For the week, let us watch 1690-1735 with bias into lower end. The strategy is to sell in two lots at 1730-1735 and 1750-1755 with tight stop for 1675-1660.
Have a great week ahead..........................Moses Harding
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