Global cues turning against into headwinds
India financial markets "golden run" since August 2013 (to March 2015) was supported by Tsunami like tailwinds from external sector. Most prominent were the ultra-supportive monetary policy regime of developed economies, sharp reversal in commodity prices and excessive FII flows into India equity and bond markets. During this period, NIFTY was up from 5118 to 9119 (by 78%), Bank NIFTY up from 8366 to 20907 (by 150%) and 10Y bond (8.40% 2024) yield down from 8.65-8.80% to 7.50-7.65%.
The euphoric rally was brought to the ground for sharp reversal on emerging risks from FED shift into rate hike cycle in H2/2015, recovery in commodity prices by 50% from the low's and significant dilution in FII appetite for India equity and Bond assets. So, all cues that drove the Indian equity and bond assets up have reversed. The impact is obvious, but hard beyond expectations. NIFTY is down from 9119 to 7940 (by 13%), Bank NIFTY down from 20907 to 17174 (by 18%) and 10Y 8.40% 2024 bond yield up from 7.50-7.65% to 8.10-8.15%.
What next? The outlook is not supportive to India financial markets. The probability of FED shift into rate-hike cycle in H2/2015 is very high; uncertainty is only from whether the start will be front-loaded or rear-ended? The India-advantage from crash in commodity prices is also behind, as most major economies would see growth pick-up. The higher demand absorbing excess supply will reinstate the bullish momentum on commodity assets, resultant Brent Crude stability at $60-70/85 is not good news for India. It is less said the better on the FII flows, who are either badly bruised or worried over the huge opportunity loss for staying invested beyond March 2015. During this period, Rupee is also down from 58 to 64 to rub salt into the wounds! Against this pain and in the absence of euphoria ahead, FII support to India financial markets will stay diluted. The other side of the coin is the set up of value-buy opportunities for new entrants and for increasing the book with better average ahead of reinstatement of bullish momentum from the base, which is not seen to be far away! All combined, the external support may not be available in the near term till clarity from the FED on start of rate hike cycle. Till then, DJIA seen in sideways mode at 17000/17150-18350/18500, 10Y US yield firm at 2.20/2.35-2.50/2.65%, USD index building steam for upside break of 93/94.50-98.50/100 and Brent Crude in bullish consolidation at 58.50/60-68.50/70. Thereafter, risk of spike in 10Y US into 2.60-2.85% and Brent Crude into higher end of long term big picture of 52.50/55-82.50/85 is not bullish take-away for India markets.
Domestic cues weak against growth - inflation conflict, leading to euphoria dilution
Most domestic cues stay suspect on the way forward. The downside risks on FY16 GDP growth target at 8.0-8.5% is major worry, as most estimates stay well below at 7.3-7.8%. The efforts to build top-line economic capacity has not yielded desired results. Investment appetite is still low and lenders continue to stay in risk-aversion mode. While the economy-build strategy is around infrastructure, there are no signs of infusion of life (and energy) to existing projects which are under stress, incurring cost overrun from delay in operations or cash flows not good enough to service huge debt burden. In the absence of desired investor appetite and hands-off stance of financial intermediaries, it is not easy to build scale around infrastructure, and to expand consumption and job creation. The agenda to expand manufacturing and agriculture sectors is still in the script writing stage and may not contribute to near term euphoria. All combined, the probability of FY16 GDP growth target falling short of 8.0-8.5% target is very high.
The outlook on the CPI inflation is not favourable. The downside risks are seen to emerge from inadequate monsoon, higher Brent Crude price and base effect impact from September 2015, not to mention about the supply side bottlenecks. All combined, RBI has already increased the January 2016 target from 5.8 to 6.0%, at higher end of the 4.0-6.0% tolerance zone. If this risk is seen with possible rate-hike from FED by September 2015, it is possible that the end of RBI rate cut cycle is not far away, if it is not already over. God forbid, if CPI inflation overshoot 6% target, RBI may be compelled to deliver rate hike to maintain the Repo rate - CPI differential at stated 1.5-2.0% spread. It would be a miracle if CPI inflation print sustain below 5.5% by January 2016 to provide space for RBI to deliver the final round of 25 bps cut in Q4/FY16. This low probability event does not provide comfort in the near term.
Barring downward pressure on growth and upside risk on CPI inflation, there are no signs of major worries on twin deficits. The FY16 Fiscal Deficit at 3.9% is not at risk and the FY19 target at 3.5% keeps enough room for Government productive investment for growth; availability of growth capital from the Government is new beginning for India. Current Account Deficit is in comfort at set target of 1-2% of GDP. It is mixed outlook on the way forward, given the pipeline measures to boost exports against the risk of adverse impact from elevated Brent Crude price. RBI is seen to be in comfort in managing Rupee exchange rate stability from sustainable net capital flows. Even in the absence of FII support, long term stable flows through FDI/ECB provides great comfort. Since August 2013, RBI $ reserves are already up from $200 to $350 billion, driving Rupee down from 58 to 64 adjusting for fair value to maintain exchange rate attractive to FDIs and competitive to exports. The resultant Rupee infusion into the system is met by Banks through CRR cash and excess SLR investment. While the cost of $ sterilisation is high, economic benefit is huge adjusting for mark-to-market gains from Rupee depreciation. Moreover, RBI is in better position to defend Rupee from lumpy hot money outflows.
Markets retain bearish undertone in nervous mode
Equity market in search of "base" to build sustainable recovery:
Post the back-and-forth play in NIFTY at 7965/8000-8465/8500 (Bank NIFTY at 17200/17350-18700/18850), the focus has already been reviewed and shifted at 7500/7650-8000/8150 (BNF at 16100/16500-17450/17850) with bias into lower end. It was also preferred for immediate term consolidation at 7900/7950-8100/8150 (17100-17225-17700/17825) before revert to bearish trend; only above 8250 (18100) is relief for not beyond 8500 (18850), seen as low probability. When to build investment book, then? The first value-buy entry point for strategic investors is seen in NIFTY at 7600-7650 and BNF at 16200-16350; till then the market tone will be on sell-on-recovery mode with high probability of back-and-forth mode at 7600-8100/8165 and 16100-17850/18100, breakout either way is not expected to sustain.
Gilts under pressure despite sharp reversal
10Y bond 7.72% 2025 is down from 7.62-7.65% to set worst case target at 7.88-7.90% (old 10Y benchmark 8.40% 2024 is down at over 8.10%, unwinding 50% of the long term rally from 8.65-8.80% to 7.50-7.65%). There are no positive cues ahead, except RBI support through OMO bond purchases. The elevated yields at mid to long tenor is burden on interest cost of the Government over time, thus marginal pressure on the Fiscal Deficit. Leaving this aside, Bank's comfort from market-to-market gains in the SLR portfolio to cover for higher credit loss provision is now gone. So, sustainability of Gilt yields at elevated levels is long term pain both for the Government and the banking system. It is less said the better on the domestic cues with next round of rate-cut not at sight, if at all. The spike in bond yields in the US and Euro zone is major pain, ahead of FED preparation for start of rate-hike cycle. The only positive is the "carry", if funded out of Repo or CBLO counters, but valuation loss is scare in the absence of base at sight. So, it is one-way supply driven state and 10Y above 7.88-7.90% (old above 8.10-8.15%) will lead to more downside pressure. All combined, the focus was shifted at 7.85-8.0% (7.72% 2025) in alignment with US 10Y at 2.35-2.50/2.65%. What to be done now? MARKET PULSE urged institutional investors (including Banks) to cut portfolio duration ahead of 2nd June monetary policy. The strategy was to exit long bonds at 10Y yield 7.62-7.65% and buy 1-3Y to play the evolving upward slopping yield curve. Now, it is good time to reverse the play - reinstating the long book at 7.90-8.0% (old at 8.10-8.20%), funding the 1-3Y book from Repo/CBLO. For traders with deep pockets, it is good entry on 7.72% 2025 at 7.90-8.0% (with stop at 8.02%). It is possible that RBI may not like to supply fresh stocks at cost above 8.0%. All taken, the tone is bearish, the mood is nervous, reversal from 7.62-7.65% into 7.90-8.0% is stretched, hence it is value-buy for big boys and institutional investors.
Rupee under pressure, but supported by RBI - how long?
USD/INR has already formed firm base at 63.45-63.70 post bullish pick-up from 61.65-62.15 to 64.20-64.35. Since then, the trading range is "fixed" at 63.70/63.80-64.20/64.30 in alignment with end June'15 $ at 63.85/64.00-64.50/64.65 and 12M $ at 67.95-68.20-68.70/68.95 - importers (and RBI) on the $ bid at lower end, and exporters (and RBI) on the $ offer at higher end. The administered price-stability is seen to be in the interest of all stakeholders. What next? The near term outlook is Rupee bearish driven by weak domestic asset markets, spike in US & Euro zone yields and DXY in bullish consolidation - all combined have set up importer's fear and exporter's greed syndrome in anticipation of short term shift in trading focus into 64.50-66.50, within rest of 2015 big picture at 63-68. The spot trading focus is now seen in traction with end June'15 $ resistance at 64.50-64.65 and end July'15 $ support at 64.35-64.50. Combination of the two will provide near term spot stability at 63.80/63.95-64.35/64.50, with RBI on both sides to ensure Rupee competitiveness to exports and sustainable FDI flows and to build $ reserves before flows dry up. Short term bias is for sustainability of $ bullish momentum into 64.85-65.00; beyond here, stay neutral on directional bias either into 63.50-63.65 or 66.35-66.50. Based on the set hedging strategy, importers are already covered in end June'15 at 63.95-64.00 and 12M $ at 67.95-68.10. Now, it is good to buy end July'15 $ at 64.35-64.50. On the other side, exporters were asked to unwind June'15 cover entry of 64.50 at 63.95, which is done on Rupee recovery into 63.75. Now, good to reinstate June'15 cover at 64.50-64.65, cover end July'15 at 64.85-65.00 and await 12M $ spike into 69.35-69.50 to cover long term receivables.
EUR/INR is steady at upper-half of set big picture focus at 65.50/65.75-73.00/73.25 (at 69/69.25-73.00/73.25). Post the 65.66 to 73.15 rally, the pair is in back-and-forth mode at 69.20 to 72.93, and now locked at zoom-in focus range of 70/70.50-72.50/73. What next, Given the near term stability in EUR/USD at 1.10/1.1050-1.1350/1.14 against USD/INR play at 63.80/63.95-64.35/64.50, EUR/INR seen in sideways mode at 71/71.25-72.50/72.75 with break out bias into 73.00-73.25. At this stage, there is no clarity to set short term bias beyond 69.00/69.25-73.00/73.25.
Have a great week ahead; Good luck!
Moses Harding
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