Prudent to cash out ahead of end 2014
Indian equity and bond markets got the desired energy from extended fall in Brent Crude below $75 (into $68-70), thus building excessive hope on rate cut from RBI ahead of expectation. In the process, NIFTY hit 8585-8600 target (post shallow correction into 8400-8450) and 10Y bond met 8.0-8.05% objective (holding firm at 8.15-8.20% support). The trigger for build-up of extreme heat on markets is from the beneficial impact from lower Crude Oil price (Brent down from over $115 to below $70) on India macroeconomic fundamentals, enabling RBI to get more comfort to turn dovish on monetary policy. What to do now having completed end-to-end chase? MARKET PULSE strategy is to end the bull-run chase in NIFTY from 7700-7750 at 8585-8600 and 10Y bond from 8.65% at 8.0-8.05%. Both are done now! What next? Prefer not to chase extended rally in NIFTY beyond 8600 and 10Y bond below 8% and see it prudent to cash out to take money off the table ahead of 2014 year end. Obviously, it is early start of Christmas & New year holidays, which is worth it after the fantastic two-way moves in 2014! Most times, a bird in hand is worth two in the bush!
Rupee may emerge as risk on financial assets:
USD/INR lift of base from 60.90-61.15 to 61.45-61.70 is not surprise (and as per script building alignment with end 2014 USD/INR target at 62.20-62.35); worry now is from extended weakness, pulling end March 2015 target of 62.85-63.35 to end December 2014; complete removal of administrative strictures on Gold imports sends necessary signal to the market that Rupee is over-valued and necessary value-adjustment is required to stay competitive to exports and foreign currency inflows. The system also needs to take note of the existing structural imbalance of excessive over-weight on Rupee from unhedged imports, mostly covered exports and large unhedged carry-trade FC liabilities (short-long term). The structural woes is also from the poor quality of reserves (largely built out of sterilisation of off-shore inflows) and huge $ appetite from RBI. All taken, Rupee is vulnerable to domestic and external shocks; and if interest rate squeeze runs ahead of inflation differential squeeze, Rupee may be at risk of one-way excessive weakness. RBI may not have band-width (or inclination) for strong protection to Rupee this time as precaution to ring-fence FII investments. While directional bias on Rupee is clear for shift into near-term trading range at 61.70/61.95-62.85/63.35 with bearish undertone, need to see FII reaction for the price-momentum; will FII see Rupee weakness as good opportunity to ship more funds enroute to equity and bond assets or drop the hot-to-hold near-term valuation and take fresh guard in 2015? Rupee immediate fortunes rest in the hands of FIIs and RBI may not react to SOS calls from importers and carry-trade FC borrowers. So, need to beware!
What can RBI do on 2nd December?
Markets have already delivered the verdict, pricing in 50 bps rate cut in rest of 2015. The option given to RBI is either to deliver in 2 baby-steps of 25 bps each or one-shot 50 bps now or in Q4/FY15 (Q1/2015). Need to see RBI's reaction to this pressure! First time, RR is seen to be caught on the wrong foot, despite stern warnings not to get carried away! What will be RR's reactive response to market stake-holders euophoria? Definitely, RR may not be seen as being catalyst to current market exuberance and he may also not be seen to dose the fire completely. The balancing act this time is not on interest rates (or liquidity) but to balance the sentiment (and sense) between bulls and the bears (of equity and debt markets). MARKET PULSE set exit dates as 27th November to 1st December; no review of this stance and would take fresh look post-policy for 2015 strategy.
Moses Harding
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