Weekly report for 17-21 December 2012

MARKET PULSE: Weekly report for 17-21 December 2012

Bearish momentum on commodity assets will trigger bullish revival for Indian economy

The evils of the Indian economy from high inflation, high trade deficit, high fiscal deficit and weak rupee exchange rate are largely linked to movement in commodity prices. The sharp (and sustained) rally, since 2008-2009 financial crisis, on essential imported commodities of Crude Oil and Gold exerted severe pressure on the efficiency of the Indian economy opening up concerns over fiscal consolidation and inflation; resultant shift into hawkish monetary policy stance exerted pressure on growth. The rally in NYMEX Crude from January 2009 low of 32.40 to May 2011 high at 114.83 was sharp at an annualised rate of 33%. During this period, Gold rallied from 680 to 1920 at an annualised rate of 60%. The combined strength of these two forces pushed the twin-deficits and inflation into elevated trajectory. The resultant shift into rate hike cycle and deficit system liquidity pushed growth momentum from above 9% to below 6%. On the other side, off-shore investors had party time; shift of liquidity and investment appetite into emerging markets drove NIFTY up from October 2008 low of 2252 to November 2010 high of 6338 at an annualised rate of 90%; followed by post Euro zone crisis low of 4531 in December 2011 at an annualised rate of 28%. The swings in FII appetite (and flows) brought volatility in rupee exchange rate up from 52.17 to 44.18 at an annualised rate of 15% (against 90% rally in NIFTY) and down from 44.18 to 54.30 at an annualised rate of 22% (against 28% fall in NIFTY). There are two lessons to be learnt: vulnerability of the Indian economy to uptrend in commodity prices and over-dependence on short term capital flows and resultant excessive volatility in rupee exchange rate from mood-swings of FIIs. The Government and RBI (in consultations with other related stake holders) should work towards building fire-wall to insulate the Indian economy (and its asset markets) from these external forces. The system cannot afford to assume that Government/RBI has no control over the movement in commodity prices or over the timing of entry and exit of short term capital flows. The good thing is that the bullish momentum on commodity assets is seen to be behind. NYMEX Crude is down from May 2011 high of 114.83 to below 87 at an annualised rate of 18%. Gold is also down from September 2011 high of 1920 to below 1700 at an annualised rate of 11%. The fear of extended rally in commodity assets (post QE3 and recent QE4) did not materialise despite very loose (and liberal) monetary policy in western economies. Commodity assets are seen to have lost the “risk-off” appetite and “protection-against-inflation” advantage at current elevated prices. The risk-reward is not seen to be favourable staying invested at these high levels due to current higher valuation, causing shift of appetite to other asset classes and thereby losing the “risk-on” advantage. If this momentum extends into medium/long term, the bearish trend of commodity assets should extend into 2010 low of 65 in NYMEX Crude and 1050 in Gold. The positive impact on the Indian economy will be significant; fear (and risk) on inflation and twin-deficits will be irrelevant leading to low interest rate and surplus system liquidity regime driving all asset markets (equity,  fixed income and currency) into bullish undertone. There will not be any concerns over investments and consumption, pushing the growth momentum back into 7.5-9.0% trajectory leading to upgrade in sovereign rating. Such is the “grip” of commodity price movements on the Indian economy! The cyclical reversal in commodity prices should bring cheer in the years ahead!

Currency market

MARKET PULSE in its weekly report identified 54.25-54.10 to cover up to 1M imports and 54.70-54.85 to cover up to 3M exports; rupee traded 54.10-54.69 before close of week at 54.48 with most trades within 54.25-54.45 zone (midpoint of set 54.10-54.60 consolidation range). In the intra-week update, it was also urged to buy end December 2012 dollars at/below 54.35 (spot at/below 54.10) and to sell 3M dollars at 55.35-55.50 (spot at 54.45-54.60) given the expectation of near term trading range for spot rupee at 53.50-55.50 with bias into lower end. What next? The external forces are strongly in favour of rupee. There will be regular flow of off-shore liquidity into debt and equity market. FIIs are seen to be interested in staying invested through rest of FY12 given the near zero interest rate returns on dollar cash. There is no risk of run-away weakness either in Bond or Equity markets. The risk-reward is clearly in favour of staying invested in anticipation of decent rally in 2013. The domestic cues are turning favourable. The Government is in over-drive on reforms after the hard fought battle to clear FDI – multi brand retail. They have not given up on next round of reforms and preparing the stake holders of the economy for bitter dose of medicine in the short term for long term well-being. The only risk factor is from lumpy dollar demand into the month/year end which would bring sudden bouts of excessive volatility as seen on late Friday; rupee was down from 54.28 to 54.69 in short time and back again into 54.40-54.60 for weekly close at 54.48. It is essential for RBI to monitor such large ticket flows in the thin/illiquid December market. MARKET PULSE continue to consider 55.35-55.50 (spot at 54.45-54.60) as good to sell 3M FC assets; on the other side, end December 2012 dollars at 54.25-54.10 (spot at 54.10-53.95) is good to cover FC liabilities having exited “long dollar” book at 55.65-55.90. For the week, let us continue to watch consolidation at 54.10-54.60; test/break either-way will be excessive. The near term outlook on shift into 2013 will be for extension into 53.85-53.60 which should hold. We will retain 12M dollars sold at 55.65-55.90 (at forward rate above 58.50) and 3M dollars (at forward rate of 55.35-55.50) for this move. On the other side, importers need to stay covered on 15-30 days dollar payables on spot rupee gains into 54.25-54.10 and look to extend coverage on move below 54.10-53.85. There will be need for RBI to shift into surplus system liquidity soon for momentum pick-up in growth and investments. RBI will use FX route to pump rupees into the system and also to replenish its dollar reserves.

EUR/USD met the set objective at 1.3155-1.3170 (high of 1.3173) to complete the rally from 1.2865-1.2880 (low of 1.2878); 300 pip rally in 5 trading sessions and 500 pip rally from 1.2660 within a month is rather sharp. Nevertheless, bullish undertone within the set near term range of 1.29-1.34 is intact. In the meanwhile USD Index is down from 80.60 into 79.60 (low so far at 79.50). What next? The immediate term trading range is seen at 1.3050-1.3350 with bias into higher end. The immediate support is at 1.3095-1.3115 which is expected to hold for 1.3350-1.3400. Watch USD Index heavy ahead of 79.85-80.00 for 78.60-78.40.

USD/JPY met the set objective at 83.85-84.35 (high of 83.96) from above 81.65 (low of 81.69). In the process it has also completed end-to-end of set near term range of 79-84; rally from 79.06 to 83.96. The intra-week update urged to unwind “long dollar” book above 83.85 and to turn “short” for correction back into 83.20-82.95 which is almost met. What next? The undertone for USD/JPY is bearish at higher end of 79-84. The weak undertone in the USD Index will exert downward pressure on this pair. MARKET PULSE would continue to see 83.85-84.35 as heavy for near term objective at 81.65-80.65. The strategy is to retain “short” book entered above 83.85 with stop above 84.35 for 81.65-81.50 (or USD Index at 78.60-78.40).

Interest rate market

10Y Bond traded end-to-end of set weekly range of 8.13-8.18% before close at 8.14%. OIS rates traded mixed; 1Y into the lower end of set receive zone of 7.63-7.68 and 5Y into higher end of 7.08-7.13%. The fear of shift into surplus system liquidity ahead of expectation has triggered the 1X5 play. What next? The undertone is bullish irrespective of delivery of rate cut this week or in January/March 2013. It is also possible that operating policy rate will shift to Reverse Repo rate before mid 2013. There will be plentiful of OMO bond purchase action from RBI to cut the 5-7% excess SLR in the system. The only risk factor at this stage is cut in HTM retention limit from current 25% at par with SLR limit of 23%. For now, 10Y Bond will be heavy at 8.15-8.17% for 8.10-8.0% into near term. The strategy is to hold on to “long” book entered at 8.18-8.22%, add at 8.15-8.17% for 8.10%. Let us continue to stay with “receive” strategy in 1Y at 7.63-7.68% (for 7.55-7.50%) and in 5Y at 7.08-7.13% (for 7.01-6.96%). The combination of rate cut action now and shift of overnight MIBOR into lower end of LAF corridor soon will retain the downward pressure on Bond yields/OIS rates.

FX premium held at the higher end of set immediate term range of 6.60-6.85% (3M) and 5.85-6.10% (12M) before close of week at 6.65% and 5.95% respectively.  The strategy was to stay received at higher end for eventual move into consolidation play at 6.15-6.65% and 5.40-5.65% post rate cut action. The trade recommendation was to stay received in December/November (11M period) at/above 3 bucks which closed at 296. For now, let us watch 6.35-6.85% in 3M and 5.70-6.05% in 12M, bias into lower end. The momentum will be mixed; interest rate “play” setting up bearish momentum while strong rupee into 54.10-53.85 will limit weakness. Over all, undertone will be bearish on accelerated supplies in the forward market.

Equity market

NIFTY traded end-to-end between set sell zone of 5930-5980 (high of 5965) and buy zone of 5880-5840 (low of 5839) before close of week at 5879. The trading range into end of month is seen to be firmly set; strong resistance at 5960-6010 and support at 5840-5790. The external support is solid with very good FII appetite. The shift into rate cut cycle will also bring domestic institutional and retail investors. The risk factor from weak macroeconomic fundamentals is diluted with build up of feel-good sentiments into 2013. Strategic investors can retain long entered in 2 lots at 5880 and 5840; watch 5800 for the final lot with stop below 5780. It will be good risk-reward to build trading book in two lots at 5960/5990 with stop/double reverse above 6015. We continue to retain near/short term focus at 2011 high of 6181 and 2010 high of 6338. For the week, let us watch consolidation at 5840-5960 with extension limited to 5790-6010 with bias into higher end.

Commodity market

Gold lost its shine ahead of set resistance at 1730 (high of 1723) for gradual reversal into set short term support zone of 1685-1660 (low of 1688) before close of week at 1695. The immediate term undertone is bearish for extension into 1660, break of which will set up bearish momentum into near/short term, opening up gradual weakness into 2012 low of 1527. For now, let us watch 1660-1710 with bias into lower end. The strategy is to stay “short” with tight stop for eventual break of 1660 for near term consolidation at 1590-1640.

NYMEX lost steam at higher end of set near term range of 82.50-87.50 (high at 87.68) before close of week at 85.80. The strategy was to sell spike into 87.50-88.50 for 82.50-77.50. The undertone is bearish and we retain the 82.50-87.50 range for the week with bias for break-down into 2012 low of 77.28.

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