Weekly report for 3-7 December 2012

MARKET PULSE: Weekly report for 3-7 December 2012

Relief rally in Indian asset markets.....can it sustain? Yes, into the near term!

It was an eventful week; dilution in political risk on reforms, conclusion of bail-out packages in the Euro zone and hope of resolution to “fiscal cliff” in the US; combination of these factors triggered a strong intra-week rally across all asset classes. The western bourses posted decent gains since mid November as investors are back into “risk-on” mode driving the USD Index down. On the domestic front, NIFTY regained its recent high of 5815 with strong weekly close at 5880, rupee posted strong reversal from 55.88 into 54.20 and Bond market maintained its bullish undertone with 10Y Bond yield down from 8.23% into 8.17%. The developments in the US and Euro zone have improved the investor sentiment and consumer confidence into the near term. The western economies are under severe growth pressure; while there are signals of recovery in the US zone, Euro zone is vulnerable and China seen outperforming rest of the World. Indian economy continues to reel under pressure. The macroeconomic fundamentals for FY13 continue to remain suspect; risk of slippage in GDP growth below 5.5%, fear of overshoot in fiscal deficit above 5.8%, rupee impact on inflation to maintain headline inflation above 7.5%, higher trade gap at over $20 Billion per month, uncertainty on sustainability of capital account flows to bridge current account gap; risk of delay in rate cut action from RBI; all these factors have severely cut appetite for investment and consumption. The lack of political consensus on reforms and delay in financial support to core sectors of the economy are major factors to delay the recovery process. The current relief rally is driven by the belief that the worst is behind and the turnaround will be in sight. The rally will lose steam if improvements in macroeconomic fundamentals are not sighted soon; first to exit will be the off-shore investors. The next couple of months into the Budget session will be crucial; till such time there is high probability of extension of this relief rally into the near term. There are no strong cues to look for extension of bullish rally into short/medium term while there are no clues whatsoever on what is in store into the long term. What is the near term impact on markets?

Currency market

The big relief is the end of rupee bear run from 51.35 at 55.88, just ahead of 55.90-56.10 seen as the worst case for rupee. MARKET PULSE urged stake holders not to stay “long dollars” at 55.65-55.90 resistance zone and to be overweight on “short dollar” book for reversal into immediate objective at 54.10-53.60. The expected reversal in USD/INR from 55.90 to 54.60 during the week was bang on with extension into solid support zone at 54.20-54.35 before close of week at 54.27. The trigger for the reversal was from signs of smooth passage of financial reforms in the Parliament, diluting the significant risk on trade (and current) account gap. Till then, rupee was completely insensitive to gains in the EUR/USD and NIFTY. What next? It is not that rupee has gone into bullish undertone; concerns from weak macroeconomic fundamentals stay valid. It would need strong political consensus on reforms and RBI’s growth supportive monetary policy to get into bullish mode. The comfort is from reforms that would attract off-shore liquidity and capital to bridge the widening gap in trade and current account; enhancement in investment limit in debt market for off-shore investors by $5-10 billion is positive but need big-bang measures that would give permanent solution to the severe strain on trade and current account. It is possible that rupee will extend its gains into 53.60-53.10 in the immediate term while finding strong support at 54.50-54.80; extension either-way will be excessive at this stage. If the theory of “worst is behind and the best is ahead” comes true, then we get into 50-53 consolidation before fiscal year end; there is limited risk of rupee weakness into 56.03-57.32 during rest of FY13. The hedging strategy is to cover long term exports at 54.50-54.80 and short term imports at 53.60-53.10. It may not be good risk-reward to stay “long dollars” at 54.70-55.20 and may not be prudent to stay “short dollars” at 53.60-53.10 till clarity emerges on improvement in macroeconomic fundamentals. For the week, let us watch 53.60-54.50 with extension limited to 53.10-54.80; bias into lower end. It would be good time for RBI to absorb excessive supplies to shore up its dollar reserves and to supply rupees into the system to cut drawdown from its LAF counter. The overweight “short dollar” book can be retained with trail stop above 54.80 while we await 53.60-53.10 to open up “long dollar” book (watch this space and intra-week updates on Twitter handle: mosesharding).

EUR/USD weakness below the set support zone of 1.2910-1.2885 could not sustain for sharp rally to take out first objective at 1.2990-1.3015; thereafter, it was consolidation mode at 1.2940-1.3040 with Euro cooling its heels post the recent sharp rally from 1.2650. In the meanwhile USD Index was steady at 80.00-80.60 (after sharp fall from below 81.50) finding good support at 80. What next? The resolutions to fiscal issues in the Euro zone are in place which has set up bullish undertone on the Euro into the near/short term. If this is followed by resolutions to the fiscal cliff in the US, the index is set for major fall into 78.60-76.50. It is possible that EUR/USD has already shifted into near term trading range of 1.29-1.35 with pit stops at 1.3070-1.3085, 1.3155-1.3170, 1.3270-1.3285, 1.3370-1.3385 and the chequered flag at 1.3475-1.3490. The bullish undertone is valid till 1.2885-1.2860 stays firm. The strategy for importers is to stay covered on short term imports (if not already done on its recent visit into 1.2660) while exporters to stay aside for covering short term exports at 1.34-1.35 (with stop below 1.2850). For the week, let us watch 1.2940-1.3170 not ruling out extension into 1.3285. Let us have close watch on immediate support at 1.2940-1.2915 and resistance at 1.3015-1.3040; break either-way will set up 100 pip move before consolidation.

USD/JPY held well at set support/buy zone of 81.90-81.65 (low of 81.67); reversal from there failed short of set weekly objective at 82.85-83.35 (hi at 82.74) before close of week at 82.50. The expected back and forth move from 82.85 to 81.65 is now done. What next? USD/JPY may not have the steam to extend gains beyond 82.85-83.35; there is risk of another steep reversal into 81.65 not ruling out further extension into 80.65, pulling the USD index along with it below 79.60. For the week, let us watch 81.65-82.85 not ruling out extended weakness into 81.15-80.65 while 82.85-83.25 stays firm. The trading strategy is to trade end-to-end with tight stop on break thereof.

Interest rate market

10Y Bond found solid support at 8.23-8.25% for back into 8.17-8.15% before close at 8.18%. OIS rates too eased from 7.78-7.80% (1Y) and 7.18-7.20% (5Y) into 7.72-7.70% and 7.12-7.10% respectively. What next? RBI’s concern is now more on liquidity; LAF drawdown is consistently above Rs.1 Trillion and it would be worse on shift into mid December. It is good that now RBI has three routes to pump in liquidity; OMO Bond purchases, CRR cut and USD purchases in FX market. The signal on rate move is mixed; rupee impact on inflation will be seen in November/December headline print, expected to be above 7.5%. RBI may decide to wait for the Budget session before rate actions. So, there is no clarity on timing of rate cut although it is long overdue. RBI also has the agenda to cut the HTM limit from 25% to 23% or shift the liquidity deficit tolerance level to 2% of NDTL as the “gap” between SLR and HTM retention limit is funded by RBI in its Repo counter. For the week, let us watch 10Y bond yield at 8.15-8.20%; 1Y OIS rate at 7.70-7.75% and 5Y OIS at 7.10-7.15%. The strategy is to trade end-to-end; having exited long bonds at/below 8.17%, reinstate at 8.19-8.21% for eventual break below 8.15% into March 2013 objective at 8.05-8.0%. It is also good risk-reward to reinstate “received book” in OIS at 7.75-7.77 and 7.15-7.17%; OIS rates is seen to be under pressure tracking higher LAF drawn down and resultant impact on call money rate.

FX premium nicely bounced from 6.0% into 6.35% in 3M and from 5.40% into 5.75% in 12M; in the process completed back-and-forth move between the set short term ranges of 6.0-7.0% and 5.35-5.85%. There is strong support at the lower end from interest rate play despite bearish pressure from exchange rate play (weak rupee). The favourable exchange rate play (strong reversal in rupee) has now pushed premium into higher end. What next? The exchange rate play will continue to exert upward pressure while tight near term money market rates into December will add momentum. For the week, let us watch 6.15-6.65% in 3M and 5.50-5.85% in 12M with bias into higher end. The strategy is to retain “paid book” entered at 6.10-6.0% and 5.40-5.35%; add on any correction into lower end and exit close to higher end and stay aside for the next trigger.

Equity market

Indian bourse (SENSEX and NIFTY) has been the star performer in the recent weeks. NIFTY has not only recovered its recent fall from 5777 to 5549 but surpassed recent high at 5815 to punch high at 5885 before posting a very strong weekly close at 5879. The credit for this strong rally is entirely to off-shore investors. FIIs are seen to have very strong investor appetite despite pressure on weak economic fundamentals and political tensions on reforms. The GDP number for Q2/FY13 at 5.3% is disappointing with high risk of slippage below 5.5% for FY13. There is little optimism on sharp decline in headline WPI inflation below 7.5-7.0% driven by weak rupee and elevated commodity prices. There may not be rate cut trigger in the near term to add momentum to current rally. During this time, there may not be clarity on fiscal cliff. So, from now to February (budget session and decision on fiscal cliff), the market is expected to stay volatile. Taking all these together, NIFTY might lose steam at 5950-6000 for consolidation mode finding strong support at 5780-5830. This will complete end-to-end move of set short term range of 5500-6000. While MARKET PULSE is confident of further extended gains into 6338 in the short term, need to stay cautious and prudent to exit “long” positions at 5950-6000 and reassess the situation after close watch on price action there. For the week, let us watch consolidation at 5830-5950 with extension limited to 5780-6000. Strategic investors who reinstated “longs” at 5610-5550 can look to unwind at 5950-6000 (with trail stop below 5830) while traders can play end-to-end with tight stop on break thereof.

Commodity market

God is in consolidation mode between strong support zone of 1705-1690 and immediate resistance zone of 1750-1765 (low of 1706 and high of 1752) before close of week at 1728. There is no change in view and retain bullish undertone for Gold into short term. It is not going to be run-away rally till resolutions to fiscal cliff is sighted. Till then, let us allow consolidation play within the broad range of 1695-1765 with extension limited to 1670-1790. For the week, let us continue to watch 1705-1750 with extension limited to 1695-1765. The strategy is to trade end-to-end with tight stop on break thereof. Strategic players can look to stay invested in two lots at 1710-1700 and 1685-1675 with stop below 1665 for 1790-1805.

NYMEX Crude traded end-to-end of set near term range of 85-90 (low of 85.36 and high of 88.99) before close of week at 88.91. The bearish undertone is now lost triggered by political crisis in the West Asia and sharp reversal in the USD Index from below 81.50. Now, there is risk of bullish extension beyond 89-90 into 91.50-95.00 while 86.50-85.0 stays firm. However, short/medium term outlook is bearish for 82.50-77.50. For the week, let us watch consolidation at 86.50-91.50 and be fleet-footed to trade end-to-end. The strategy is to trade end-to-end between 86.50-85.00 and 90.00-91.50 with tight stop on break thereof.

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