MARKET PULSE: Weekly report for 21-25 January 2013
RBI’s dilemma on rates: over-drive on fiscal consolidation vs “aam aadhmi” headwinds
The build-up of strong hope (and expectation) of 25-50 bps rate cut on 29th January post weak November IIP data, good December WPI inflation print and Governments’ aggressive stance on fiscal consolidation triggered strong gains in all asset classes from the lows’ of August-November 2012 driving NIFTY above 6050, Rupee below 53.85 and 10Y Bond yield into 7.80%. The response of the Government to dilute economic risks from inaction in policy reforms and high fiscal deficit is laudable. The implementation of fuel price hike, linking bulk purchases to market rates and gradual increase (over 18 months) for retail consumption is seen as innovative. The road-map for fiscal deficit into short/medium term provides great comfort that fuel subsidy will not be an expense item in the books of the Government post run-down of pipe-line fuel price hikes. The deferral of GAAR implementation beyond 2014 will be relief for off-shore investors. In short, the Finance Minister is seen to have delivered beyond expectations of the stake holders, including the RBI. The concern however is from elevated headline CPI inflation at over 10%, high (and unaffordable) prices of essential items at the ground for the majority of the population, and impact of fuel price hikes on primary articles which will add to burden on the Middle Class, Lower Income Group and the Poor, the “aam aadhmi”. RBI may want (and wish) to delay rate cut action till supply side concerns are addressed to control prices of food and other essential items; lower interest rates and resultant higher demand (and consumption) will lead to price pressure. RBI is also seen suspect on its ability to manage huge Current Account deficit, adding to downside risks on inflation and exchange rate. Having said these, RBI is indeed in preparedness for rate reversal cycle but seen to be not sure of the timing; it is better late than being early, if it could help the majority of the population! So, it is a 50:50 chance (on 29th January) between delivery of 25 bps cut in policy rates and sticking to the pause stance till March/April policy reviews. RBI would also get more clarity by then, from FY14 Budget estimates on macroeconomic indicators and can afford to deliver larger dosage of rate cut if twin-deficits trend into right direction. It would be a big disappointment to stake holders if 25 bps rate cut is not delivered, most having already given up 50 bps expectation. But, RBI’s pause mode may not be bearish on markets when sentiment (and confidence) has improved significantly bringing the investors (and consumers) into risk-on mode.
What is the impact on markets?
Interest rate market
10Y Bond could not retain gains into 7.80%; weakness from intra-week low of 7.79% was sharp into 7.89% before close of week at 7.87%. What next? It would be a period of consolidation ahead of RBI’s rate decision on 29th January. Till then, 7.80-7.83% will limit gains while not ruling out extended weakness beyond 7.87-7.90 into 7.95%. MARKET PULSE strategy to “unlock” investments at/below 7.80-7.83% is now seen as prudent (and sensible) move post the long chase from 8.23-8.28%; it was considered high risk-low reward trade strategy to stay invested at/below 7.80% in the absence of clarity on 50 bps rate cut on 29th January. The huge excess-SLR investments in the system to the tune of Rs.5 Trillion and pipe-line bond supplies from RBI (for rest of FY13 and into FY14) carries higher risk of sharp correction (and unwinding of excessive gains) in the absence of aggressive rate cut on 29th January. For the week, let us watch consolidation at 7.81/7.83-7.88/7.90 not ruling out extended weakness into 7.93-7.95% which should hold. The trading range thereafter is seen at 7.80-7.90% on delivery of 25 bps rate cut or into higher range of 7.85-8.0% on pause mode; however, rate cut expectation in March/April 2013 will limit weakness beyond 8%. The strategy is to reinstate investment book in 2 lots at 7.88-7.90% and 7.93-7.95%; need to keep good appetite for extended weakness into/above 8%.
OIS rates traded perfect to the script; end-to-end of set weekly range of 7.50-7.60% (1Y) and 7.10-7.20% (5Y) before close of week at 7.55% and 7.15% respectively. It would be period of consolidation till RBI’s rate decision is out of the way. For the week, let us continue to watch the set ranges of 7.50-7.60% (1Y) and 7.10-7.20% (5Y); bias into higher end not ruling out extended rally into 7.63% and 7.23% which should hold. The trading range thereafter is seen at 7.45-7.55% (1Y) and 7.05-7.15% (5Y) on delivery of 25 bps rate cut or into higher range of 7.55-7.70% (1Y) and 7.15-7.25% (5Y) on pause mode; rate cut expectation in March/April 2013 will arrest rally beyond 7.70% (1Y) and 7.25% (5Y). The strategy is to stay fleet-footed trading end-to-end of set weekly range and stay “light” into the policy.
It was 3X12 play in FX premium; 3M stayed steady below strong resistance at 7.35% while 12M rallied into 6.25-6.40%. MARKET PULSE revised the trading range of 12M at 6.0/6.10-6.30/6.40% post RBI’s dollar support window to Banks for export finance. It is seen as great move to achieve two objectives: one, to cut demand for forward dollars (from importers) and to shift forward market into supply driven mode (by leading supplies from exporters) to provide relief to spot rupee and the other, is to cut the arbitrage between FX and MM rate curve through upward pressure on short term money market rate curve. This signal was seen as RBI’s lack of comfort on rate move; 25 bps rate cut will not push shorter end of the rate curve down significantly or pause mode on rate will not be bearish on spot rupee. For the week, let us watch consolidation at 7.25-7.50% (3M) and 6.25-6.50% (12M); bias into higher end on strong momentum from both interest and exchange rate play. The strategy is to trade end-to-end and await more cues to build strategic book.
Exchange rate market
What a move in USD/INR? It was sharp turnaround from 55.10-55.60 to 53.60-54.10. MARKET PULSE revised the trading range (post WPI data intra-week report) to 53.60/53.85-54.85/55.10 (sell zone) with set up of relief rally in rupee into lower end. Rupee rallied sharply from intra-week low of 54.89 to 53.70 for strong weekly close at 53.71. The strategy for exporters to stay fully hedged (3M at/above 56.25 and 12M at/above 58.50) and importers to stay away for 53.60-53.85 has worked well; 3M dollar is now sharply down at 54.70 and 12M at 57.10 (from the recent high of 56.30 and 58.53). What next? The undertone for rupee is indeed bullish but the extent (and speed) of rally from now on is not clear. The risk from huge Current Account Deficit is diluted on shift of forward market into supply driven mode but many analysts continue to retain risks of slippage into 58-60. MARKET PULSE has set USD/INR range for 2013 at 51.35-55.88/56.43, hence the recommendation to sell 3M above 56.25 and 12M above 58.50. While the current forward rate of 3-6M may not look attractive for exporters, shorter end (3M at 54.70) will attract importers’ interest having seen spot rupee at 55.38 in early January; however, exporters will have comfort to sell 12M dollars at/above 57.50. The flows in the forward market will be mixed with combination of demand up to 3M and supplies in 12M and beyond. RBI also has the need to build its dollar reserves and does not get too many opportunities like this; ability of RBI to defend rupee weakness is limited given the low dollar reserves and deficit rupee system liquidity. Now is the good time to build dollar reserves and cut draw down from LAF counter. What next? It would be period of consolidation with mild bullish undertone for rupee. The first sign of extension of rupee bull-run will be on test/break of 53.60 for 53.15-53.30 and 52.90-53.05 while 54.10-54.25 stays firm and reversal beyond 54.35-54.50 will scare the rupee bulls. For the week, let us watch consolidation at 52.90/53.30-54.10/54.25. The trading range thereafter is for consolidation at 51.35/52.60-53.60 on delivery of 25 bps rate cut or into higher range of 53.60-54.35/54.85 on pause mode; shift into growth supportive monetary stance in March/April 2013 will limit rupee weakness beyond 54.85-55.35. The strategy for exporters is to retain “short dollar book” with trail stop above 54.25/54.35 while importers to cover 3M dollar liabilities at spot at/below 53 (3M forward rate at/below 54; mid rate of 2013 range of 51.35-56.43). Traders who chased the move from 54.85-55.35 into 53.60-53.85 can reinstate “short dollar book” at 53.95-54.20 for 53.00-53.25.
EUR/USD was in nice trading range at 1.3250-1.3400 (down from 1.3403 to 1.3256, up again at 1.3401 before close of week at 1.3317) between set buy zone of 1.3245-1.3270 and sell zone of 1.3385-1.3410. What next? Repeated failure of EUR/USD at 1.3380-1.3405 resistance zone is a serious concern into the near term despite smart rally from 1.2997. There is build-up of risk for reversal into 1.3150-1.3250 while 1.3400-1.3500 stays firm. The favourable interest rate play and the need for much stronger Euro to retain bearish undertone on the USD Index (which is firmly supported by much weaker JPY) are factors that provide comfort to Euro bulls. For the week, let us watch 1.3150/1.3250-1.3400/1.3500. The strategy is to trade end-to-end with no clarity on break-out direction as yet.
USD/JPY posted smart rally from support/buy zone of 87.25-87.75 (low of 87.77) to meet the objective at 89.65-90.15 (high at 90.18) before close of week at 90.05; weekly close above psychological resistance at 90 is bullish bringing 94.98 into the radar. For the week, let us watch support at 89.25-89.60 to hold for 91.10-91.40 and prepare for extended rally into 94. The near term range is now shifted to 89-94.
Equity market
NIFTY posted smart rally from 5965-5980 support/buy zone (intra-week low at 5962) to pass through immediate resistance at 6045-6060 (high at 6083) before strong weekly close at 6064. The bullish trigger was from deferral of GARR beyond 2015, aggressive positioning of the Government to cut fuel subsidy to zero in 18 months and strong headline WPI inflation data building expectation of 25-50 bps rate cut on 29th January. While these factors brought cheer to FIIs to pump in more monies, domestic investors are seen to shift investments from fixed income into equity. The bullish undertone is firm with focus at 2011 high of 6181 and thereafter into 2010 high of 6338. The only risk factor at this stage is delay in rate cut action from RBI but correction, if any will be shallow not beyond 5960-6000 on expectation of big-bang cuts in March/April 2013. For the week, let us watch 6020/6050-6150/6180 with bias into higher end. The trading range thereafter will be for consolidation at 6100-6350 on delivery of 25 bps rate cut or shift into lower range consolidation at 5950-6100 on pause mode; expectation of shift into aggressive rate action in March/April 2013 will limit weakness not below 5900. Strategic investors can stay invested at 5950-6050 (with stop below 2012 close of 5905) for 6300-6350 into near/short term.
Commodity market
Gold posted smart rally from 1625 to hit 1695-1710 objective (high at 1695.50) before close of week at 1683.30. The undertone is mildly bullish for extension into 1710-1735 while 1660 stays firm. For the week, let us watch 1660/1675-1710/1725 with bias into higher end but not above 1735. The strategy is to buy dips into 1660-1675 for 1720-1735 and switch side there for sharp correction into 1625 in the near term.
NYMEX Crude traded end-to-end of set weekly range of 92/93-96/97 with intra-week rally from low of 92.95 into 96.04 before close of week at 95.49. The undertone is firm and carries the risk of 100% unwinding of recent reversal from 100.42 to 84.05. For the week, let us watch 93/94.50-97.5/99 with bias into higher end but not above 100.50. The strategy is to buy dips into 93.00-94.50 for 99-100.50 and switch side there for sharp correction into 88 in the near term.
Have a great week ahead............................................Moses Harding
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