Better comfort on inflation than ever before
It was a shocker on the previous 2nd June review when RBI set a hawkish tone with January 2016 CPI target at 6% (higher end of the 4-6% long term tolerance zone) against risk of Brent Crude price rise beyond $70 a barrel into 85 and downside pressure on Rupee exchange rate into 65-67. The monsoon worries and resultant supply side issues exerting pressure on CPI was concern for RBI. The FED rate hike outlook in September pushed US 10Y yield into higher end of 2.20-2.60% was seen as external risk in play. All combined, it was prudent for RBI to stay in caution without sending unrealistic (and optimistic) guidance.
Between 2nd June to 4th August, all cues have turned for better. Brent Crude shifted focus from 70-85 to 45-60, Rupee is firm at 63-65 comfort zone despite USD strength (against global currencies), US 10Y yield down at lower end of 2.20-2.60% and Gold is down from over $1200 to below 1100. The sharp 20% fall in Brent Crude and 12.5% ease in Gold (and sustainable bearish undertone through 2015-2016) takes out the structural woes on inflation from elevated Current Account Deficit and downside risk on Rupee exchange rate. There is also great comfort on fiscal prudence beyond FY16 from growth driven higher revenues and better efficiency on cost-revenue management plugging slippages on revenue collection and cost optimisation. All taken, RBI has now long term comfort on twin-deficits and Rupee exchange rate which were resistive for shift into dovish monetary policy stance. The risk from higher US yield retaining the medium/long term India yields at elevated levels is blessing in disguise to build steep upward sloping money market curve to provide cost efficiency to borrowers at shorter end of rate curve and yield advantage to investors at the longer end of the curve. The resultant excess demand for funds at shorter end and abundant supply at longer end will lead to price stability exerting squeeze in the money market rate curve. It is win-win dynamics for all stakeholders.
The positive impact (from downtrend in twin deficits and stability in Rupee exchange rate) on inflation is significant; risk of CPI beyond 6% is near zero and probability of ease into lower end of 5-6% in FY16 is high before shift into 4-5% in FY17. The only worry in the radar is the monsoon impact on food prices, and the Government is seen committed to bridge the demand-supply gap to give RBI the desired comfort. All taken, the inflation outlook is positive than ever before!
Guidance shift from hawkish to dovish building rate cut hope in H2/FY16
RBI has no option but to tone down its hawkish tone of 2nd June. While retaining the January 2016 CPI outlook at 6%, it is in order to build optimism signalling worst case scenario of 6% for improvement into 5-5.5% by March 2016 into FY17. This outlook with build 25-50 bps rate cut in H2/FY16, between October 2015 to March 2016. The outlook is for 25 bps cut in Q4/2015 and follow-on 25 bps cut in Q1/2016. The sentiment ahead is positive for retaining operative policy rate at 7.25% for now with downward bias into 7% in Q4/2015 on CPI outlook at 5-5.5% by end FY16. There after if CPI retains momentum for easing further into 4-5%, RBI has the option to either push Repo rate down to 6.75% or shift the operating policy rate from 7% to 6% (lower end of LAF corridor) through shift of system liquidity from deficit to surplus with CRR cuts or aggressive USD purchases and OMO bond purchases. Till now, RBI has taken a balanced stance through 75 bps rate cut in H1/2015 to support growth and sterilisation of surplus system liquidity through combination of refinance restrictions at Repo counter and OMO bond sales to control inflation. Most cues have now turned in favour to shift stance from neutral (and balance) mode to more accommodative stance.
India financial markets mixed between inflation relief and growth worries
RBI money market policy stance will turn supportive to financial markets in the medium/long term. The short term concerns are from downside risks on FY16 GDP growth momentum with most expectations around 7.5%, significantly below the aspiration target of 8-8.5%. The euphoria from expectation of giant-steps big-bang policy reforms is behind and the momentum is seen to be in baby-steps, seen as chicken feed against voracious appetite. The investor (and lenders) ability to fund growth is high but the appetite is low from risk aversion. The risk-reward trade off is not seen to be in favour to make money chase investment and lending opportunities. The Government is making efforts to pull appetite from private investors through higher budgetary allocation for investment in infrastructure and core sectors. These efforts lead to dilution of pessimism but not seen as good enough to build optimism in the short term through FY16. All combined, the make-or-break factor is the ability to set up growth momentum building positive outlook for stake holders to revise outlook from below 7.5% into 7.5-8.0%. At this stage, FED preparedness for shift into rate hike mode in September 2015 is not seen as major hurdle, and India financial markets seen resilient to absorb upto 50 bps hike in rest of 2015. If by then India CPI shift to stability mode at 4-5%, FED rate hike over 50 bps in 2016 may not seen as resistive headwind.
India equity market in neutral consolidation mode in the short term
While downside risks seen limited with interest rate and liquidity support, upside gains from here may not be significant against earning pressure from baby-steps capacity expansion. The financial services sector is under serious trouble from deterioration in asset quality, low credit pick up and limited upside from investment book, all leading to earning pressure and low profitability. The capital infusion in PSU banks is seen to keep them afloat rather than to fund top line balance sheet growth. All taken, the low seen in 2015 is safe with not enough bullish momentum to post a new high. NIFTY 2015 range has been at 7950-9150, and now in indecisive mode around mid point 8550. Given the mixed cues between inflation comfort and growth concerns, it would be in order for neutral consolidation at 8250-8850 for rest of 2015. Beyond here into Q4/FY16, bias is neutral between bullish shift into 8850-9150 or slide back to 7950-8250.
Bank NIFTY rest of 2015 range is seen at 17850/18000-19850/20000, and now heavy above mid point of 18850-19000. The short term outlook is for neutral consolidation at 18350-19500 for rest of 2015. Beyond here into Q4/FY16, bias is mixed between bullish shift into 19350-20000 or slide back to 17850-18500.
Money market yields at ease in the shorter end and steady in the longer end
The short term play is seen in the 1x10 Gilt yield spread, seen to widen from current 25-35 bps to 50-65 bps. While short term (3-12M) Treasury Bill yield trend down into lower end of 7.15-7.50%, 10-15Y Bond yield seen steady at 7.70-7.85%. This outlook covers uptrend in US 1Y yield spike into higher end of 1.0-1.25% and 10Y into 2.35-2.60% with India-US yield spread around 6% in 1Y and at 5.15-5.65% in 10Y while CPI stay ease at 5-6%. The downside risk on India Gilts is also driven by huge pipeline auctions (and OMO) supply against low investor appetite from Banks adjusting the excess SLR book with incremental requirement from top-line deposit growth. All combined, rest of 2015 range is seen restricted at 7.0-7.50% (3-12 month) and 7.70-7.85% (10-15 years). The strategy is to stay invested at higher end (with positive carry funded from Repo/CBLO counters) while not chasing gains below the lower end.
Rupee fortune boxed between RBI $ appetite and exporter/investor supply
USD/INR has been in administered mode at 63.30-64.30 with bids from RBI (and 1M import hedge) at lower end and supplies from RBI (and 1-12M export cover) at higher end. The play was in perfect traction with MARKET PULSE trading (and hedging) range of 63.20/63.35-64.20/64.35. The focus was also reviewed up at 63.60/63.85-64.60/64.85 in alignment with DXY recovery from lower to higher end of 93-98 and covering time decay. Given the demand-supply dynamics in the forward market between upto 1M $ bids from importers and 1-12M $ supplies from exporters, Rupee is not vulnerable to sharp downside risks in rest of FY16 with focus not beyond 63-65/67. While the bulk $ supply in cash market will be absorbed by RBI, any lumpy demand (from PSUs or FII pull-out) will be used by RBI for time decay value adjustment. The need is to administer Rupee value to stay competitive to exporters and attractive to sustain long term inflows (avoiding hot money exit). All combined, Rupee impact from divergent monetary policy actions of RBI and the FED may not be significant or excessive. It is good to retain short term focus at 63.85-64.85 and stay risk-neutral (or off) at either end with short term import hedge at lower end and short - long term export cover at higher end tracking 1M USD/INR at 64-65 and 12M at 68-69, overshoot either way not to sustain.
EUR/INR strategic focus range at 68.50/69.50-72/73 held well against sideways play in EUR/USD at 1.08-1.13 and USD/INR at 63.30-64.30. Given the near term focus in EUR/USD at 1.08/1.0850-1.11/1.1150 against USD/INR at 63.85/64-64.50/64.65, EUR/INR focus is set at 69.50/69.75-71/71.25, not ruling out downside bias into 68-68.50. It is prudent for exporters to stay covered across 1-12M at/above 71 encashing time value and hedge against short/medium term bearish undertone.
Good luck and have a great week ahead!
Moses Harding
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