Weekly report for 10-14 December 2012

MARKET PULSE: Weekly report for 10-14 December 2012

Focus now shifts to RBI’s stance on policy rates from Government’s policy reforms

It was rough sail-through for FDI – multi brand retail in the Parliament; related financial (and tax related) reforms are also expected to go through, thanks to the support (and magnanimity!) of BSP and SP. The fear is from the bottom-line reality; no further reforms can go through without the blessings of Ms.Mayawati and Mr.Mulayam Singh. It can be safely assumed that it is consolidation phase for reforms and pipe-line plans if any will be shelved for 2014 and beyond! It is now to feel the impact on the ground from effective implementation and execution of reforms for tangible improvement in growth, inflation and twin-deficits. The focus now shifts on RBI and its action on 18^th December mid-quarter review of monetary policy. RBI has been vocal in considering elevated headline WPI & CPI inflation as major risk to growth and low real interest rates not hurting growth momentum and capacity expansion. RBI is also seen to stay suspect on policy reforms and fiscal consolidation. If this stance is retained, there is no case for rate cut this time. The trending in growth, inflation and fiscal deficit will be the key factor for rate decision; it is two out of three against rate cut. The downtrend in growth momentum below 5.5% would need monetary support through low interest rate regime and surplus system liquidity; but elevated inflation and fiscal deficit would put RBI in defensive mode and delay rate cut action. There is no confidence at this stage for downtrend in headline WPI inflation below 7% (and CPI below 9%). There is also serious concern on fiscal deficit with risk of slippage beyond the tolerance zone of 5.3-5.8%. Till RBI gets good comfort on inflation and fiscal deficit, it could only support growth through guidance on rates and not through action. The concern is on liquidity; drawdown from RBI’s LAF/Repo counter is high with average of close to Rs.1 Trillion against its tolerance level of Rs.65K Crores. The comfort however is from the 2% “gap” between SLR and HTM retention limit which is funded/financed at Repo counter. The drawdown from LAF counter is at 1.0-1.5% of NDTL as against 4% excess SLR holding by Banks. So, there is sufficient system liquidity but in the wrong hands; lenders are content with low risk-low reward Government bond asset and stay reluctant to divert funds into high risk corporate credit (while there is limited demand from low risk credit). RBI has already cut CRR by 175 bps to cover this “gap” and would continue to conduct OMO bond purchases to reduce the excess SLR holding by Banks. There is no strong case to cut CRR given the comfortable system liquidity but the need is to continue its OMO bond purchases to cut the excess SLR in the system. It does make sense for RBI to wait till February 2013 budget session for rate cut action; by then better clarity on inflation and fiscal deficit would emerge to either kick-start the rate reversal cycle or to hold on for some more time. The expectation from RBI on 18^th December will be either 25 bps CRR cut to neutralise advance tax outflow or maintain status-quo if the plan is to conduct week-on-week (or fortnightly) OMO Bond purchases. A 25 bps rate cut will be a pleasant surprise while status-quo will signal a harsh stance. It is prudent to deliver 25 bps CRR cut to retain the hope and confidence of the stake holders and to ensure post-policy price stability with mildly bullish undertone.

Interest rate market

10Y Bond traded steady at 8.15-8.18% before close of week at 8.17%. There has been significant release of pressure as 10Y bond yield has nicely trended down from set buy zone of 8.22-8.25% into strong resistance zone of 8.17-8.15%. RBI’s OMO bond purchases and expectation of shift into rate cut cycle in January-March 2013 have helped to ease pressure despite the significant risk from cut in HTM limit. There will be price stability now at 8.13-8.18% with extension limited to 8.10-8.20%. The strategy is to retain investments entered at 8.22-8.23% and add at 8.18-8.20% for post policy rally into 8.13-8.10%. This move may not be triggered by rate cut action but the guidance into the next policy review is expected to stay dovish. It is also possible that the Governor may surprise the market by delivering 25 bps rate cut when none expects it from RBI. It is good risk-reward to stay “overweight” on bond investments (with positive “carry” from Repo/CBLO counter) given the rate cut expectations in the near/short term and continuation of OMO Bond purchases by RBI.

OIS rates have gradually unwound its recent gains for move into 7.65-7.60% (1Y) and 7.10-7.05% (5Y) from recent peak level of 7.80% and 7.20% respectively before close of week at 7.64% and 7.06%. What next? It would be period of consolidation above 7.60% in 1Y and 7.0% in 5Y. Having chased the move from 7.80% and 7.20%, it is prudent to unwind “received book” and stay aside for correction back into 7.70-7.72% and 7.10-7.12%. For now, we watch consolidation at 7.60-7.70% in 1Y and 7.02-7.12% in 5Y; extension either-way will be difficult to sustain. The strategy is to trade from “received” side as near/short term trend is bearish. The only risk in 5Y is from squeeze in 1X5 spread when operating policy rate gets shifted from Repo rate to Reverse Repo rate which is not relevant for the next 3-6 months. However, it is long overdue for sharp down move in shorter end to build tenor premium into the rate curve. The strategy is to reinstate “received book” in 5Y OIS at 7.08-7.13% (with stop at 7.15%) for 6.96-7.01; this support zone is considered good for corporate borrowers to hedge long term floating rate rupee loans. There is not much of reward in the 1Y OIS play given the steady 1X5 spread and negative “carry”. Banks who have large Call/overnight borrowing exposure can look to pay 1Y OIS at 7.60-7.50%; fixing 1Y cost at this level is not bad at all.

FX premium met the set objective at 6.50-6.65% (3M) and 5.95-6.05% (12M) to complete the sharp rally from 6% and 5.4% respectively. It gave opportunity to unwind “paid book” and switch sides to build “received book” for correction back into 6.35% and 5.65%. The interest rate play is in favour of reversal in premium while mixed on exchange rate play. The reversal from current level will be sharp if spot rupee holds above 54 for weakness into 55 and beyond. For now, let us watch 6.25-6.65% (3M) and 5.65-6.05% (12M). The strategy is to retain the “received book” entered at 6.55-6.65% and 5.95-6.05% with tight stop for 6.15% and 5.4%. There is no case for sustainability of 3M premium below 6.15-6.0% and 12M below 5.4-5.35% till system liquidity is shifted from deficit to surplus to guide the operating policy rate into lower end of the LAF corridor, the Reverse Repo rate; hence the strong “call” to initiate “paid book” in 3M at 6.15-6.0% and in 12M at 5.40-5.35% which also coincided with expectation of sharp reversal in spot rupee from 55.88 to 54.04 to guide swift rally into 6.65% and 6.05% in quick time. The near term outlook is for stability at 6.15-6.40% (3M) and 5.40-5.65% (12M).

Currency market

Rupee weakness above 54.80 was short-lived as rupee gained sharply from intra-week low of 54.96 into 54.04 before consolidation at 54.10-54.60 for close of week at 54.47. Over all, rupee has traded end-to-end of set short term support zone of 55.65-55.90 (low of 55.88) and resistance zone of 54.10-53.85 (high of 54.04), thus pushing the 12M forward dollar rate from high of 58.90 to low of 57.30 (current 57.65). The strategy to stay “overweight” on short dollar book at 55.65-55.90 for move below 54.60 into 54.10-53.60 has worked well. Importers were also urged to unwind import hedge “long dollar” book at 55.65-55.90 for re-entry below 54.60 into 54.10/53.60. What next? We are into December market known for volatility in illiquid market conditions. Having got the move from 55.65-55.90 to 54.10-53.85, it is time to have a fresh look on the way forward. The cues into the near term are at best mixed. The bullish cues from reforms are now out of the way. The attention will now be on implementation and execution of reforms (and its impact on macro fundamentals); pipe-line bunched up demand into month/year end, sustainability in FII flows ahead of their financial year end etc.  Rupee might get into consolidation at 54.05-54.95 with extension limited to 53.80-55.20. There is no clarity at this stage for directional break-out beyond 53.60-55.20. So, it is prudent to cover imports in two lots at 54.25-54.10 and 53.85-53.70 with trail stop above 55.20 while exporters look to cover dollar receivables in two lots at 54.70-54.85 and 55.10-55.25. The landing from 55.65-55.90 into 54.10-53.85 has been smooth and swift and it is possible that rupee has already shifted into new near term trading range of 53.50-55.50 from earlier 54-56. If all goes well on reforms (attracting stable FDI flows) and resolution to “fiscal cliff” (shifting investors into risk-on mode and bearish set up on the USD), rupee should get into bullish undertone for short/medium term stability at 50-53. The extension of bearish momentum in Crude and Gold prices will support rupee recovery. So, importers need to be more dynamic in hedging activity to avoid getting locked into wrong side of the exchange rate while exporters should not miss out unsustainable rupee weakness. 12M forward dollar at 58.50-59.00 is seen attractive for exporters which should provide support in spot rupee at 55.25-55.50. On the other hand, the risk of rupee weakness into 56.03-57.32 into the near term is not out of the way, thus providing strong support in 12M dollars at 57.00 limiting spot rupee strength beyond 53.75-53.50; hence the expectation of near term spot rupee consolidation at 53.50-55.50 (and 12M dollars at 56.75-58.75; test/break either-way will be difficult to sustain).  

Euro failed ahead of set strong resistance at 1.3140-1.3170 (high of 1.3126) and posted strong reversal into set objective at 1.2905-1.2880 (low at 1.2878) before close of week at 1.2924. MARKET PULSE was prepared for minimum 150 pip reversal from below 1.3140 but ended up with deep 250 pip extension. The sharp reversal was triggered by expectation of rate cut from ECB in early 2013 taking comfort from low inflationary expectation in the Euro zone and better than expected economic data from the US. The dollar is also expected to get support till “fiscal cliff” is out of the way. What next? EUR/USD should hold at strong support of 1.2865-1.2890 to retain its bullish undertone for extension of gains beyond 1.3140-1.3170; else risk is for deeper correction into 1.2665-1.2640 before up. The immediate resistance is at 1.2965-1.2990 ahead of 1.3015-1.3040. For now, let us watch 1.2865-1.3015 and stay neutral on break-out direction; break either-way will be good for minimum 150 pips. The strategy is to trade end-to-end with stop/double reverse on break thereof.   

USD/JPY traded to the script between set buy zone of 81.80-81.65 (low of 81.69) and sell zone of 82.65-82.80 (high of 82.82) before close of week at 82.46. The undertone is bearish into the near term but would allow extension into 83.25-84.00 to gain momentum for sharp move below 81.65-81.50 into 80-79 within the set near/short term range of 79-84. This should complete back-and-forth move since the rally from 79.06. For now, let us watch consolidation at 81.85-83.35 and await cues for extension into 80.65-80.00. This move will be supported by lower break-out in USD Index range of 79.60-80.60 which posted strong rally from intra-week low of 79.57 into 80.65 before close of week at 80.40. The strategy is to buy in two lots at 82.15-82.00 and 81.75-81.60 (with stop at 81.45) and sell in two lots at 82.85-83.00 and 83.25-83.40 (with stop at 83.55). Strategic players who chased the move from above 79 to below 83 can now look to sell at 83.25-84.00 with stop above 84.25 for 81.65-80.65.

Equity market

The sharp rally in NIFTY from 5580-5550 (low of 5549) has now met its set objective at 5930-5980 (high of 5949) before close of week at 5907. The immediate term outlook is mixed with weekly close at neutral zone of 5880-5930. The inability to retain gains above 5930 and good demand below 5880 highlights a period of consolidation ahead. The passage of FDI Retail bill and pipe-line reforms will bring cheer to FIIs but the liquidity flow from them is expected to be limited ahead of financial year end and Christmas/New Year holidays. FIIs will stand to gain from the sharp rally in underlying equity asset and also from the exchange rate, thus building incentive to realise profit. There is not enough appetite from domestic investors to support the market. There is risk of deep correction into 5800-5750; hence urged to unwind strategic investments entered at 5610-5580 on rally into 5930-5980. It is prudent to re-enter on clear break of 5980-6000 rather than exposing the book to sharp sell-off. For now, let us watch consolidation at 5800-6000; break either-way may not have the desired momentum to sustain. It is normal in December market that trading range will be minimum 500 points; so far we have seen 5838-5949. We need to stay prepared for either sharp rally into 6338 or sharp reversal into 5548? The sharp reversal into 5548 will be on unwinding of investments by FIIs and the rally into 6338 will need FIIs increasing the book size and stay invested into 2013. NIFTY’s directional guidance into end December is at the hands of fair-weather friends while domestic cues (and support) is neutral. The strategy is to trade end-to-end of 5800-6000 with stop/double reverse on break thereof which should be good for 250-350 points. It is difficult to read the pulse of FIIs ahead of their financial year end to get a clear view on the direction; gut feel is that it may be good risk-reward to stay invested on correction below 5880 for 6330 with stop below 5780.

Commodity market

NYMEX Crude nicely traded end-to-end between set sell zone of 90.00-91.50 (high of 90.33) and buy zone of 86.50-85.00 (low of 85.68) before close of week at 85.93. The near/short term undertone is bearish; hence we shift into new trading range at 82.50-87.50 with bias into lower end. The strategy is to sell spike into 87.50-88.50 with tight stop for 82.50-82.00 ahead of 77.75-77.25 for 100% reversal of recent rally from 77.28 to 100.42. The short/medium term undertone is bearish. The sharp rally from 32.40 (since December 2008) lost its steam from the high of 114.83 (May 2011) and the reversal process is steady and has already taken out first support at 95.37 and looks set for taking out the next one at 83.34 followed by 73.62. If this trend continues, there is strong story in waiting for the Indian economy and its asset markets.

Gold is losing its shine; inability to take out resistance at 1750-1765 (high at 1754) for reversal back into strong support at 1670-1685 (low at 1683) is a concern. There has been repeated failure at 1735-1760 resistance which shifts the undertone to neutral. The high seen at 1795 (in October 2012) and 1920 (in September 2011) is seen to be safe and focus now shifts to strong support at 1660 while 1730 stays firm. The positive developments in the US and Euro zones and resultant shift of investors sentiment into risk-on mode will continue to keep the tone bearish into the near term. The trading range for now is at 1660-1730. The strategy is to trade end-to-end with tight stop and stay neutral on break-out direction; however test/break of 1660 will quickly expose 1527 (seen in May 2012) which triggered sharp rally into 1795 (by October 2012). The bearish momentum in commodities (Crude Oil and Gold) will set up bullish momentum in rupee exchange rate diluting the fear from widening trade (and current) account deficit.

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