Weekly report for 18-22 June 2012

MARKET PULSE: Weekly report for 18-22 June 2012

It is rather straight-forward for RBI to cut policy rates and inject liquidity

The revised (and actual) economic data for FY12 is on hand now. During the course of FY12, GDP growth was down from 8% to 5.3% (from Q1 to Q4); sharply down on quarterly sequential basis. During the same time, headline inflation was down from 10% to 7.5%; down on quarterly sequential basis. The core inflation was down at 5% while food and fuel inflation were high driven by high crude oil prices and supply-side issues. The impact from the growth-inflation dynamics resulted in sharp overshoot in fiscal deficit and swift shift into tight monetary conditions. The reason for pressure on growth in FY12 is attributed to weak external sector; tight liquidity and high interest rates. The major cause for high fuel inflation was due to sharp rise in BRENT crude from $98 to $128 a barrel and rupee weakness from 44 to 56; resultant 60% impact on landed rupee cost of crude oil was not passed through to the consumers, thus releasing pressure on inflation but exerting pressure on fiscal deficit. The pressure on food inflation is attributed to higher demand not being met with adequate supplies. The factors concerning RBI in these issues are liquidity and cost of liquidity. The task on hand for RBI (and the Government) is to reverse the trend for FY13. The GDP growth has to be pushed from 5.3% to minimum 7% and headline inflation from 7.5% to minimum 6% on quarterly sequential basis. What is the trend on inflation? There will be sharp downtrend in fuel inflation; BRENT crude is already down from $128 to $97 and looks good extended reversal into $85 during course of FY13. It is also possible that the worst for rupee is already behind and rupee will get into consolidation mode at 53.5-56.5. So, taking these two factors together, there is good chance of sharp reversal in fuel price inflation and the Government has enough room to reduce cost subsidisation without hurting inflation. On the other hand, food price inflation is set to peak; the demand is already is at its peak while good monsoon and bit of effort from the Government to address supply side concerns will moderate food price inflation. While RBI has limited role to play to contain food price inflation, it is important for the Government to provide comfort to RBI in this regard. The outlook on core inflation is neutral to soft. The higher demand from uptrend in GDP growth will be met with capacity expansion on shift into growth supportive monetary stance; domestic investments will pick up significantly tracking low interest rates and easy liquidity to build capacity and supplies. The money market conditions have also turned positive for the Government to complete its FY13 borrowing programme at affordable cost; aggressive measures on fiscal consolidation will send positive vibes into the future. It is clear that downside risks to growth is much severe than upside risks to inflation in FY13. Taking all these together, it is rather straight-forward for RBI to shift system liquidity from deficit to surplus and effect rate reversal cycle. The process has already begun; RBI has delivered 125 bps CRR cut and 50 bps rate cut. But despite these actions, system liquidity is short by Rs.1 Trillion and short term rates are at elevated levels with 3-12M rates at 9.25-9.5%. It is important that RBI continue with these measures till monetary system turn supportive to growth. What will RBI do on 18^th June? There is demand from stake holders to release cash into the system. Some large players demand as high as 100 bps CRR cut. It is also obvious that CRR cut (by less than 150 bps) without rate cut is irrelevant at this stage as operative policy rate will continue to stay at higher end of LAF corridor, the Repo rate at 8%. The minimum expectation from RBI is for delivery of 50 bps CRR cut and 25 bps rate cut to avoid bearish set up across equity, fixed income and currency markets. In this case, it is important to keep option open for more rate cuts into the future. There is another important political development that has hit the system. Congress Party has come out successful in handling the political crisis from the Presidential election; FM’s elevation to the President of India is certain now. This gives comfort to stake holders that UPA Government will make the best use of rest of its term (till 2014) to address issues relating to reforms and fiscal consolidation. These expectations build a strong case for delivery of 50 bps cut in CRR and 50 bps cut in policy rates to get the best of impact on asset markets. MARKET PULSE sets 51% probability on 50 bps cut in CRR and policy rates and 49% probability on 50 bps CRR cut and 25 bps rate cut (with guidance on more rate cuts into the future).

Interest rate market

It was a volatile week in Bond/OIS market. 10Y (8.79% 2021) Bond traded end-to-end of set weekly range of 8.25-8.35% before close of week at 8.33%. The new 10Y (8.15% 2022) was more volatile for sharp gains into 7.96% before close of week at 8.03% where we asked not to chase gains beyond 8%. 1Y OIS rate was more volatile but stayed within the set weekly range of 7.40-7.65% with low of 7.44; high of 7.62% before close of week at 7.57%. 5Y OIS rate was relatively steady trading end-to-end of 7.10-7.25% before close of week at 7.17%. What next? 10Y Bond has priced-in 50 bps CRR cut and 25 bps rate cut. It would need 50 bps rate cut to allow extended rally beyond 8.25% (8.79% 2021) and 8.0% (8.15% 2022). Given the positive expectations into the future, the trend into FY13 is positive but it is also fact that bullishness in bond market was also driven by RBI’s OMO bond purchases. Therefore, it is important for RBI to continue its use of OMO bond purchases till most of market borrowing for rest o FY13 is out of the way. It is also possible that RBI may not like extended rally in 10Y bond yield below 8% at this stage and may discontinue OMO to provide post-policy price stability in new 10Y Bond yield at 7.95-8.10% and 8.20-8.35% (8.79% 2021). For the week, let us watch 10Y (8.15% 2022) bond yield at 7.95-8.05% with test/break either-way to attract. Strategic players can continue to stay invested for short term move into 7.65-7.5% while traders look to play end-to-end of this range. The risk of new 10Y bond trading at discount (yield above 8.15%) is limited at this stage; hence would consider 8.05-8.15% as good for keeps into short term.

1Y OIS rate will find strong support at 7.40-7.45% zone till system liquidity shifts into surplus mode while 5Y OIS rate stay in consolidation mode tracking sideways trading mode in the Bond market. However, short term trend is for move lower ahead of signs of shift in operating policy rate from Repo rate to Reverse Repo rate; need to have close watch on system liquidity. For the week, let us watch 1Y at 7.35-7.60% and 5Y at 7.05-7.20% with bias into lower end. Strategic investors can hold on to “received book” for short term target at 7.10-7.0% (1Y) and 6.90-6.80% (5Y).

12M FX premium nicely traded end-to-end of set weekly range of 4.75-5.25%; sharply up from lower end to higher end before close of week at 5.2%. In the meanwhile 3M was in tight consolidation mode at 6.25-6.5%. What next? The interest rate play sets up bearish momentum while exchange rate play is neutral. There should be significant dilution in upward momentum from now on. For the week, let us watch 3M at 6.0-6.5% and 12M at 4.75-5.25%. The strategy now is to stay “received” in 12M at 5.25-5.35% for 4.85-4.75%.

Currency market

USD/INR played perfect to the script; rupee posted weekly low of 56.07 before close of week strong at 55.39. MARKET PULSE continued to highlight the risk of staying “long dollars” above 56 and considered good to cover 3M/September 2012 exports at forward value above 57 while asking importers to stay away for spot move into 55.00 to cover spot next-1M payables. There was release of bearish pressure on rupee driven by bullish signals in equity market and USD Index losing steam above strong resistance at 82.60; fell from high of 82.73 to 81.48 before close of week at 81.59. What next? The serious concerns on political and economic woes stand diluted. The smart handling of UPA’s presidential nominee brings in confidence on the ability of UPA to bring consensus to roll-out critical reforms and fiscal consolidation. It is crisis time and there is hope of managing the crisis well by the UPA. Also, RBI’s shift into aggressive growth supportive stance will address economic woes. However, market forces are neutral and mixed. There is no clarity on movement in USD Index; there is strong support at 81.05-80.90 which will limit rupee gains beyond 54.90. Rupee unwinding its entire weakness from 55.01 to 56.52 will add confidence to rupee bulls. For the week, let us watch 55.00-55.60 with extension limited to 54.65-55.95. It is good for importers to cover near term imports on extended gains into 55.00-54.65 and to unwind “short dollar” positions and stay square for fresh cues. The risk of reversal from here into 55.60-55.95 is not ruled out for near term consolidation at 54.65-55.95 tracking reversal in USD Index from 81 to 83.50.

EUR/USD moved up sharply from support at 1.2450-1.2425 (low of 1.2441) into the set resistance/sell zone at 1.2670-1.2730 (high of 1.2664) before close of week at 1.2636. The trade ideas suggested in twitter was good for 150 points (stay tuned to twitter account for intraday trade ideas on currencies). What next? The developments in the Euro zone and expectations of QE3 from the FED provide solid two-way volatility in EUR/USD. Now, it is important for EUR/USD to lose steam at solid resistance zone of 1.2725-1.2750 (USD Index around 81) to keep the expected move into 1.2250-1.2200 in play; else the relief rally in EUR/USD will extend further into 1.29-1.30. It will be a volatile week and we track 1.2425-1.2725 and stay neutral on break-out direction which could then extend to 1.2225 or 1.2925. The strategy is to sell at 1.2700-1.2750 and buy at 1.2450-1.2400 with stop/reverse for 1.2925 or 1.2225 respectively.

USD/JPY met the set objective at 78.50 (low of 78.59) while staying below 80 (high of 79.74). In the meanwhile EUR/JPY held well above set strong support at 98.50 (98.68) and reversal from there failed at 100.30 (high of 100.35) for close of week at 99.50. What next? USD/JPY looks good to test the set near term target at 77.75 and for further extension into 76.00-75.50 before reversal. This move along with reversal in EUR/USD from 1.2725 could guide EUR/JPY below 98.50 into recent low of 95.64. For the week, let us watch USD/JPY at 77.50-79.25 and EUR/JPY at 97.25-100.25 and the bias is into lower end. The strategy is to stay “short” for this move.

Equity market

NIFTY was well supported by rate cut expectation and shift into growth supportive monetary stance to hold well above 5000 (low of 5015) but did not generate enough momentum to take out strong resistance at 5150-5200 (high of 5146) but weekly close at 5139 is bullish into the near term. In the meanwhile DJIA sailed through strong resistance at 12700 (high of 12774) for strong weekly close at 12767. Over all, domestic and external cues turned supportive for the NIFTY but despite these strong forces, inability to take out 5200 is a worry. What next? DJIA is set to recover in full the sharp fall from 13338 to 12035 (since 1^st May to 4^th June) with immediate resistance at 12840 and 13060 while 12685-12530 holds firm. This move in DJIA has perfect reflection in NIFTY since the rally from 4770 (since 4^th June) to 5150 (8% rally in NIFTY as against 10% in DJIA). The domestic cues from RBI and political gains of Congress over the Presidential election should add momentum to NIFTY with targets at 5300/5450 on conclusive break of 5200. This would also open up 100% retracement of 5630 to 4770 (since 26^th February to 4^th June) while 5100/4975 stays firm. For the week, let us watch 5100-5300 not ruling out extended rally into 5450. The risk factor to this move is on disappointment from RBI to drive NIFTY into 5000-4975 which should hold.

Commodity market

Gold has now traded end-to-end of 1560-1640 range (from 1561 to 1633) before close of week at 1627. This also completes the 100 dollar trade set up that we had from 1535 to 1640. What next? Gold is looking bullish to take out strong resistance at 1640-1645 for extended rally into 1700 and beyond to get the focus into recent high of 1790. For the week, let us watch 1590-1660 not ruling out extended rally into 1690 and prepare for further extension into 1730. The strategy is to stay “long” for this move with stop at 1585.

NYMEX/WTI crude is held well above strong support at 80-81 (low of 81.07) and into consolidation mode at 81-85 before close of week at 84.03. It is in order to allow this consolidation after sharp reversal from over 110 since early March 2012 by over 25%. What next? Now, any correction rally should fail at 85-87 for test/break of 81.25-81.00 into 75 to complete end-to-end move of the set short term range of 75-110. Beyond there, slow recovery in global economy and increased supplies can get the focus into 65 which is great news for Indian economy. For the week, let us watch 80-87 with test/break either-way not expected to sustain. The strategy is to trade end-to-end of this move with tight stop on break thereof.

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

     

feeling RBI's pulse ahead of midquarter policy review

Will RBI shift priority to growth and deliver 50 bps cut in CRR and policy rates?

The expectation build-up of shift into aggressive growth supportive monetary policy, post weak GDP/IIP data; sharp fall in crude oil price and rupee stability below all-time low with signs of appreciation pushed Money Market rate curve down; 3-12M curve at 9.0-9.5% from 9.75-10%. 10Y Bond yield was sharply down to 8% on the new 10Y Bond from coupon cut-off at 8.15%. The party was gate crashed by bad inflation data; headline for May at 7.55% (core below 5%) which sent bond prices crashing down on dilution in expectation of 50 bps rate cut. How will RBI react to this bad set of data on growth and inflation? RBI as custodian of monetary system has multi-tasking role to play. It has to control inflation and money supply; ensure sufficient system liquidity at affordable cost; flow of liquidity to desired sectors; maintain monetary system as support to growth; control over cost of Government borrowing; manage FX impact on monetary system etc. It is not an enviable role when the operating environment is tough driven by weak domestic and global cues with limited support from the political system.

RBI will closely watch expectation (and trend) on headline (and core) inflation and money supply before shifting into its secondary role of extending support to growth. The money supply is already down and the system has huge capacity to absorb cash without hurting inflation. The pressure on inflation will moderate on low growth, extended reversal in BRENT Crude and release of pressure on rupee. These factors supported by release of supply-side concerns due to good monsoon and administrative measures from the Government should provide relief. On the other hand, growth pressure is severe with FY13 estimates moving below 6% and monetary environment not conducive to spur domestic investments. Over all, downside risk to growth is much higher than upside risk to inflation; though the expectation (and the trend) on growth and inflation may be assumed to be neutral (and mixed), chances of headline inflation moving below 6% is higher than pickup in growth momentum above 6%. This triggers the need to get into next round of monetary easing despite inflationary concerns staying valid into the near term. Moreover, there may not be resolutions to fiscal consolidation when growth is under pressure.

The expectation now stands diluted to 50 bps CRR cut and 25 bps cut in policy rates from earlier 50 bps across all. It is possible that RBI covers this up with 75 bps CRR cut as the need to conduct OMO bond purchases is diluted driven by stable rupee and low bond yields, 10Y yield below Finance Ministry’s tolerance level of 8.20%. This should provide price stability in 10Y Bond (8.15% 2022) yield at 7.95-8.20%. This range is valid till operative policy rate stays at higher end of LAF corridor of 6.75-7.75% (on assumption that 25 bps rate cut as given) and the risk of weakness into 8.15-8.20% will be valid on pipe-line bond supplies without OMO bond purchases. Beyond there, the next trigger will be on shift of operative policy rate from 7.75% to 6.50% (with another 25 bps rate cut) on or before September mid quarter review through combination of CRR cuts and OMO bond purchases. This move will be dependent on removal of stagflation risks driven by sharp fall in inflation and moderation in growth. Let us review this position as we move into July quarterly review and it is considered good to stay invested (10Y at 8.10-8.20%) ahead of shift of system liquidity from deficit to surplus which would then trigger 10Y yield below 8% into 7.65-7.50% before end of 2012.

The risk factor to this expectation is that of delivery of CRR cut without rate cut which will drive money market rates and bond yields much higher. The system is short by over Rs.1 Trillion (approx 1.5% of NDTL) and delivery of 50-100 bps CRR cut (without rate cut) will continue to keep operative policy rate at current level and resultant cut in OMO bond purchases will further add to bearish set up. It is important for RBI to manage liquidity injection through combination of CRR cut and OMO till most of government borrowing is out of the way.

To conclude, we will set a 51% probability for 50 bps CRR cut and 25 bps rate cut and 49% probability for 50 bps CRR cut and 50 bps cut in Repo and Reverse Repo rate. Either of these actions will provide price stability in 10Y bond yield at 7.95-8.15%; 50 bps rate cut into the lower end and 25 bps rate cut into higher end; test/break either-way not expected to sustain. It would be painful if RBI delivers 50-75 bps CRR cut without rate cut or leave things unchanged. Therefore, there should be action with combination of CRR and policy rate and there is no case for delivery of aggressive rate cut without CRR cuts. Let us see what RBI delivers on 18^th June? Will it play to the gallery (50 bps CRR cut and 25 bps rate cut) or stay conservative sticking to its primary role of containing inflation (50 bps CRR cut without rate cut) or play tune with the ministry to support growth (50 bps CRR cut and rate cut)?

Moses Harding   

Run up to 18th June midterm review of monetary policy and research report for the week 11-15 June 2012

MARKET PULSE: Weekly report for 12-15 June 2012

Run up to RBI’s mid quarter review of monetary policy on 18^th June 2012

The sluggish growth momentum and moderation in headline inflation has pushed RBI for move into aggressive growth supportive monetary stance ahead of expectations. The FY13 Budgetary estimates on GDP Growth above 7% looks very ambitious in the absence of favourable monetary conditions with immediate need to drive system liquidity into surplus mode and at low (and affordable) cost of funds. The concerns over fiscal deficit and core inflation have lost its priority as low growth will cause severe damage to fiscal consolidation. There has been significant release of pressure on Current Account deficit triggered by sharp fall in crude oil price and reduction in bullion imports. The rate cut expectation and resultant relief to Equity and Fixed Income asset classes will bring back FII investors into the market to remove worry on deficit Balance of Payment. Now, S&P has come out with threat to downgrade sovereign rating below investment grade if issues related to growth are not immediately resolved. It is also an alarm bell to political leaders if they do not stand together on reforms and fiscal consolidation. It is a crisis time and it is time to act fast and hard. MARKET PULSE highlighted the risk of India’s exit from the investment grade BRICS group given the complexities across political, economic and monetary systems which has put the macro fundamentals of the Indian economy at risk.

The system liquidity will be short by over Rs.1 Trillion post advance tax outflow. There is strong case to cut CRR by minimum 50 bps. This will also release pressure on RBI on the need to continue with its OMO bond purchases when longer tenor Bond yields are already down. However, stand alone CRR cut may not guide rates down significantly till operative policy rate is maintained at higher end of LAF corridor, the Repo rate. There is also immediate need to pull domestic investments (and consumption) by moving the operative policy rate to the lower end of LAF Corridor, the Reverse Repo rate through infusion of sufficient cash into the system; most of Q1 of FY13 is already behind and any further delay will hurt FY13 Budgetary aspirations. This brings the need for delivery of rate cut of 50 bps to push overnight MIBOR from above 8% into 7.5%. There is tremendous pressure to bring in optimism into the stake holders who have revised the GDP growth estimation to around (or below) 6%. The change in sentiment will happen if RBI could set the road map for CRR at 3.5% and operative policy rate at 6.5% during the course of H1 of FY13. RBI has already taken three big steps through delivery of 75 bps CRR cut; 50 bps CRR cut and 50 bps rate cut since mid March 2012. It is essential (and critical) to continue with these actions when the need is high. The best (and prudent) option at this stage will be delivery of 50 bps cut each in CRR, Repo rate and Reverse Repo rate. There will be disappointment on delivery of 25 bps rate cut along with 50 bps CRR cut; considered as baby step. It would also be good if RBI could review and bring down the MSF rate to Repo rate till RBI is in a position to cut SLR. The 2% SLR refinance facility at MSF counter at rate 1% above Repo rate deprive the facility of investors to get these excess SLR investments refinanced from CBLO market at rates within the LAF corridor. Moreover, this facility is not being used by Banks and it will be good if RBI drive this 2% SLR liquidity (into the system) at Repo rate. This is essential to drive deposit rates down to effect pass-through to lending rates. Over all, RBI has two options on hand: (a) 50 bps cut each in CRR and policy rates (51% probability) and (b) 50 bps cut in CRR and 25 bps cut in policy rates (49% probability). Any other options in the form of 25 bps rate cut without CRR cut or 50 bps CRR cut without rate cut will be very negative on the market while 50 bps rate cut without CRR cut will be neutral. MARKET PULSE would expect giant strides from RBI when the operating environment is tough and business (and investor) confidence is weak; to revive optimism in the minds of investors, consumers and business enterprise. It would be fair to expect delivery of 50 bps cut each in CRR, Repo rate and Reverse Repo rate. If the undertone (and road map) is set for move into 6.5% operative policy rate and 3.5% CRR before end of September 2012 (ahead of shift into busy season), the short term targets will be at 7.0% (1Y OIS); 7.5% (364D T-Bill); 8.0% (10Y G-Sec) and 7.0% (5Y OIS).

Currency market

Rupee weakness lost steam ahead of the upper end of set weekly range of 54.65-55.95 (low of 55.91) for a one rupee correction into 54.92; but fell sharply to 55.82 post S&P threat of downgrade before close at 55.75. Rupee losing the one rupee advantage in quick time is not good at all into the near term. It is unfortunate for RBI that S&P threat has come at the wrong time to make things difficult to arrest rupee weakness from now on. There has been significant improvement in CAD and BOP. The sharp fall in BRENT Crude from over $128 a barrel to below $100 since March 2012 is big relief to cut import bill in dollar terms. It is a different story that this benefit is not extended to inflation or fiscal deficit due to sharp fall in rupee during the same period. There is appreciable fall in bullion, capital goods and non-essential imports. The signal of rate reversal and shift into surplus system liquidity conditions will divert off-shore liquidity into Indian Debt and Equity capital markets to keep BOP positive which in turn will drive forward market into supply driven mode. Over all, it is possible that rupee has seen a short term low at 56.52 and looks set for unwinding of its weakness from 48.60 to 56.52 with immediate target at 54.65. If all goes well, rupee should further extend its gains into 53.50 to complete end-to-end of revised short term range of 53.50-56.50. What is the risk factor to this move? The rally in USD Index from 78.60 met with strong resistance at 83.50 (high of 83.54); reversal from there has been sharp for move below 82.00 but the risk is of retest of 83.50 while 81.80 stay firm. This could open up rupee weakness into 55.95-56.50 but not expected to post a new all-time low given the improved conditions in CAD and good FII appetite into debt and equity capital market. It is possible that S&P will take note of RBI’s growth supportive monetary stance and delay rating action on India. For the week, let us watch 54.90-56.25 with extension limited to 54.65-56.50; initial bias will be into higher end but expected to attract good supplies for gradual reversal into lower end in due course. The strategy is to sell 3M/September 2012 exports at 57.25-57.50 while importers stay away for spot reversal into 54.90-54.65 to cover up to 1M imports around 55.00. Strategic traders can look to sell at 56.25-56.50 with affordable stop for short term target at 53.50.  Fleet footed traders can play end-to-end of this range with tight stop on break there-of; it would be a very low risk-high reward trading opportunity, similar to the recent one rupee move (both ways) from 55.91 to 54.92 to 55.82. There is no reason at this stage to review the set short term range of 53.50-56.50; we will watch price action at 55.95-56.50 to get more clarity on directional break-out.

The rally in EUR/USD from above the first pit stop at 1.2250-1.2200 (low of 1.2286) had very good momentum to generate nearly 400 pip rally to high of 1.2668 where “relief rally” fizzled out for move below 1.25. The financial bail-out in Spain and relatively highly overvalued US Dollar created “short squeeze” to provide bit of relief to Euro which is looking weak and vulnerable.  What next? The rally in EUR/USD looks good but not seen as bullish reversal at this stage. There will be good selling appetite at various levels which would limit gains at 1.2750. Over all, trend for EUR/USD is bearish and it is matter of time before 1.25 gives way for one more look at 1.2286 before heading into 1.22-1.18. For the week, let us watch consolidation at 1.2250-1.2750 and test/break either-way will attract. The strategy is to sell at 1.2700-1.2750 (with stop above 1.2775) for 1.2300-1.2250.    

The rally in USD/JPY from 77.65 lost steam ahead of psychological resistance at 80 (high of 79.78) while EUR/JPY posted a 5 big figure rally from 95.57 to 100.88 driven by relief rally post EUR 100 Bio bail-out package to Spain. What next? Euro should enjoy the Spain package advantage till another set of weak news from Portugal or Greece hit the market. US economic woes and resultant QE3 expectations before Q4 of 2012 also provides support to non-dollar currencies. While the trend is down, we may need to allow for recovery in the immediate term. USD/JPY can extend its gains above 80 into 81.00 while support around 79 holds firm. Similarly, EUR/JPY can extend its relief rally into 102.00 (higher end of recent near term range of 97-102). We need to watch price actions in USD/JPY above 81 and in EUR/JPY around 102 to fix the next big move. For the week, let us watch USD/JPY at 78.50-80.50 and EUR/JPY at 98.50-102.50 and stay neutral on break-out direction. The strategy is to play end-to-end of these ranges with tight affordable stop on break thereof.

Interest rate market

Bond market is bullish driven by rate cut expectations; 10Y Bond yield was in consolidation mode at 8.30-8.35%. In the meanwhile new 10Y benchmark bond was subscribed at a very aggressive coupon of 8.15%. OIS rates are steady around 7.60% in 1Y and 7.25% in 5Y. What next? Bond market has priced-in 25 bps rate cut and 50 bps CRR cut. The expectation is for more aggressive actions in injecting liquidity to drive the call money rate into the Reverse Repo rate. The monetary system cannot support growth by operating at the higher end of LAF corridor with huge daily draw down from LAF counter. For the week, let us watch 1Y OIS at 7.40-7.65%; 5Y OIS at 7.10-7.30 and 10Y Bond (8.79% 2021) yield at 8.25-8.35% and new 10Y Bond (8.15% 2022) yield at 8.05-8.15%. Over all, it is good to stay invested in bonds (and received in OIS) into the monetary policy when RBI is not expected to send unpleasant surprises into the market. Having said these, there is no clarity at this stage to chase gains beyond the set lower ends and would be prudent to exit and stay square and allow decent correction to re-build investment book.

12M FX premium played end-to-end of set 4.75-5.25% before close around 5%; the bounce from 4.75% was sharp while being heavy at 5.15-5.25%. In the meanwhile interest rate play kept the shorter end bit soft with 3M premium trading around 6.5%. For the week, let us watch 3M at 6.25-6.75% and 12M at 4.75-5.25% with test/break either-way not expected to sustain. The trading strategy is to pay 12M at 4.85-4.75% and receive at 5.15-5.25% with tight affordable stop. The short term trend continues to stay bullish while the near term outlook is mixed driven by contradictory forces between interest rate and exchange rate play.

Equity market

The strong rally in NIFTY from the first buy level of 4775 (low of 4770) extended beyond 5000 (into high of 5124) only to erase gains post S&P threat for close at 5054. All factors in favour of NIFTY struck at the same time; rate cut expectations from RBI, financial support to Spain and QE3 expectations in the US. NIFTY also tracked sharp reversal in DJIA from 12035 to 12650. There are lot of positive take-away into the near term. The sharp reversal in DJIA back above strong support at 12200 is positive with focus back into the earlier resistance at 12550-12700; break of which will be good. On the domestic front, RBI is expected to turn growth supportive not ruling out more monetary actions into the future. The concerns are from the Euro zone; the rupee and S&P. There are no clear cues to take short/medium term view at this stage and would stay neutral to mildly bullish on the near term outlook and look for good levels to “short” the NIFTY. MARKET PULSE highlighted the risk of India being pushed out of BRICS group and S&P has highlighted the same risk factor of India losing its investment grade status and losing the advantage it gained being part of the BRICS group. Let us now set aside S&P factor and have close watch on the rupee and the Euro zone. For the week, let us watch two-way sideways trading mode within 4700-5200 with initial bias into lower end. The strategy is to play end-to-end of this range as test/break either-way will attract.

Commodity market

Gold traded to the script; rallied sharply from 1527 (above the set buy zone of 1525-1485) to hit the set objective at 1640 (high of 1640.50); reversal from there held above the buy zone of 1560-1535 (low of 1561.44) before getting into consolidation mode at 1580-1610. What next? Gold continues to retain its bullish undertone and looks good for test/break of 1640 into 1680-1715 while 1560-1535 stay firm. For the week, let us watch 1560-1640 with bias for extended gains into 1680. The strategy is to stay “long” for this move with tight stop on break of lower end.

It was perfect move in NYMEX Crude; first chased the reversal from above 110 to below 83 and got opportunity to reinstate “shorts” at 85.5-87.5 as correction from 81.21 failed at 87.03 and now in consolidation mode around 83. What next? The undertone continues to be bearish and there are no factors to look for bullish reversal. For the week, let us continue to watch 75-88 with bias into lower end. The strategy is to stay “short” for this move with tight stop on break of higher end.

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

Weekly report for 4-8 June 2012

MARKET PULSE: Weekly report for 4-8 June 2012

Currency market

Rupee has now completed end-to-end of set short term range of 52-57 (sharply down from 52.42 since 30^th April to 56.52 in one month flat) for weekly close at 55.54. In the process, extension beyond the set sell zone of 56.10-56.40 could not sustain where we asked to sell 3M/August dollars at 57.00-57.50 (high of 57.45). We also considered it dangerous to stay “long” dollars at 56-57 given the risk of sharp reversal while extended weakness be shallow and not beyond 57.00 in the worst case. During this time, USD Index rallied from 78.60 to 83.50 before close of week below 83.10. The rally in USD Index has mirror effect on the USD/INR on weekly close basis; but for RBI’s support (and measures), the damage would have been severe. What next? There is no support for rupee from macro fundamentals of the economy; downside pressure on GDP growth and deficit system liquidity are not good signals into the future. The market forces are also strongly in favour of the US Dollar; not ruling out extended rally in USD Index into 85.25-85.50 (and EUR/USD into 1.20-1.18) before sharp reversal tracking build-up of roll out of QE3. Despite these strong headwinds against rupee in the near term, there are some factors in support of rupee. There should be genuine dollar supplies at 56.00-56.50 if forward premium stays at elevated levels; 3M forward dollars above 57 and 12M forward dollars above 59 would attract exporters’ interest. These are the levels considered very good to convert 3-5 year rupee liabilities into USD or JPY. RBI has two strong weapons on hand now: one, to supply dollars to OMCs in a discreet manner without opening a special counter and the other is the option of big-ticket USD Bond issuance to glut the market with dollar supplies. This may not hurt exporters as lower spot will be covered through sharp spike in forward premium; in the process making the forward dollar unattractive for importers. The flood of dollars in spot market and shift of forward into supply driven mode will be rupee bullish. It was mentioned in MARKET PULSE that opening a special counter will only accelerate demand for forward dollars to avail the subsidised rate of spot dollar. BRENT Crude below $100 and cut in import from Precious metals and capital goods will reduce pressure on Current Account Deficit into the short term. Over all, there has been tremendous dilution in the bearish set up on rupee and is expected to stay neutral (to bullish) and build momentum for gradual move into its realistic value at 52.50-53.50. For the week, let us watch 54.65-55.95 with bias into lower end and not ruling out further extension into 53.50 in due course. In the meanwhile USD Index is expected to stay in consolidation mode at 82.00-83.50 with test/break either-way to attract. MARKET PULSE continues to see spot weakness into 56.00-56.50 good for exporters to sell 3M/August 2012 dollars while importers stay away for spot reversal into 54.65-54.50 to buy 1-2M dollars at value below 55 keeping enough appetite to buy on extended rupee gains into 53.50-53.00. There is no risk factor at this stage to look for extended rupee weakness beyond 56.50. It is crisis time for the Indian economy and the system cannot afford a highly devalued currency when it struggles to address issues relating to growth, fiscal deficit, inflation, liquidity and interest rates. The short term range for USD/INR is now revised to 53.00-56.00 with extension limited to 52.50-56.50 and it is believed that end-to-end move has already begun from recent low of 56.52.

EUR/USD played end-to-end of set weekly range of 1.2250-1.2625; fell sharply from high of 1.2624 to 1.2286 before close of week above 1.24. This move has more or less completed the chase from above 1.30 to 1.22. The bearish factors out of the Euro zone is now met with weak economic data from the US with expectation build up of QE3 before last quarter of 2012. This expectation should provide strong support to EUR/USD at 1.2250-1.2200 but there may not be momentum for rally beyond 1.2500-1.2550. For the week, let us watch 1.2250-1.2500 with overshoot limited to 1.22-1.2550. The strategy is to sell at 1.2475-1.2525 (with stop above 1.2550) for 1.2250-1.2200. There is no comfort as yet to initiate trade from “long” side as the risk of extended weakness into 1.18 is valid where we look to buy for sharp reversal back to 1.30.

It was bulls-eye hit in EUR/JPY chasing the complete move from 102 to 97 but the extended move into 95.50 (low of 95.57) was surprise and was momentary for weekly close above 97. In the meanwhile, USD/JPY too fell from 80 to the set objective at 78.25-77.75 (low of 77.65). What next? Let us allow for consolidation with upward bias before gaining momentum for reversal to take out 77.65 and 95.57 respectively. For the week, let us watch USD/JPY at 77-79; bias is for eventual test/break of lower end into 76.00-75.50 before reversal. The strategy is to stay “short” for this move. In the meanwhile, watch consolidation in EUR/JPY at 95-98 with bias into lower end for further extension into 90 before reversal. The strategy is to stay “short” for this move. Over all, short term range for USD/JPY is at 75-80 and for EUR/JPY at 90-100. There would be good opportunity to trade end-to-end of this range.

Interest rate market

MARKET PULSE had strong views of RBI’s shift into growth supportive monetary stance sooner than later and accordingly had advised strategic players to stay invested in 1Y Bond at 8.30-8.40% and 10Y Bond at 8.55-8.65% with short term target at 8.0-7.75% (1Y) and 8.35-8.25% (10Y). Similarly it was considered good for strategic players to stay received in 1Y OIS at 8.05-8.10% (for 7.75-7.65) and 5Y OIS at 7.55-7.65% (for 7.35-7.25). These short term objectives were met (ahead of expectation) post poor Q4 GDP data and FY12 GDP growth at 6.5%. Now, most economists have reviewed FY13 GDP forecast to around 6% against ambitious target of 7%. This has build up strong expectations of rate cut on 18^th June.  Given the crisis situation where growth has to be given priority over inflation, the expectation is now unanimous for combination of rate and CRR cut on 18^th June. It is also the need to shift the system liquidity from deficit to surplus for effective price transmission. These expectations were good enough to drive the 10Y yield down from 8.55% (set buy zone of 8.53-8.58) to 8.33% before close of week at 8.36% and 1Y Bond yield down to 8% (from recent high of 8.35%). OIS rates are also sharply down at 7.68% (1Y) and 7.30% (5Y). What next? Now, combination of 50 bps rate cut and 100 bps CRR cut will drive the operative policy rate to 6.5% (and overnight MIBOR at 6.75% from current 8.25%). The shorter end of the MM rate curve will be sharply down from current elevated levels of 9.75-10.0% across 3-12M tenor. It is possible that we see a quick shift in 3-12M CD rates to 8.0-9.0%. RBI will prefer to deliver this in two phases; 50 bps CRR cut and 25 bps rate cut on 18^th June and similar action on July quarterly review. MARKET PULSE will look for 50 bps CRR cut and 25 bps rate cut on 18^th June and similar action in July to drive operative policy rate to 6.5% by August-September ahead of shift into busy season. For the week, let us watch 10Y bond yield at 8.25-8.40% with test/break either-way to attract while 5Y OIS rate stays in consolidation mode at 7.25-7.40%. There are no strong cues at this stage to look for extended rally beyond the lower end given the huge pipe-line supplies. It is also possible that RBI will stop its OMO bond purchases on rupee stability. It is good to invest “long” and borrow “short” as momentum picks up in rate reversal cycle.  It is good to maintain longer duration in bond portfolio till September and await fresh cues for direction beyond there.

FX premium eased on RBI’s dollar sales and good supplies in the forward market to absorb weak rupee; reversal in 12M was sharp from high of 5.60-5.70% to 4.90% and then into consolidation mode at 4.90-5.15% before close of week at 5%. In the meanwhile, not much of action in the shorter end of the curve with 3M steady at 6.75-7% before close of week at 6.8%. What next? The signals are neutral and mixed; interest rate play will exert downward pressure and lower USD/INR will provide strong support with upward momentum. For the week, let us watch consolidation in 3M at 6.5-7.0% and 12M at 4.75-5.25%. It is important for RBI to maintain premium at elevated levels to cut demand for forward dollars and the risk of move below 4.75% will be on extended weakness in rupee beyond 56.50-57.00, considered as very low probability at this stage. The strategy is to pay 12M at 4.90-4.75% (with stop below 4.65%) for 5.25-5.40% while spike in 3M above 7% is good to “receive” to fund FC uses through rupee sources. RBI may need to open up access to off-shore liquidity to maintain premium at elevated levels and for realistic reflection of interest differential to cut arbitrage play which builds up short term USD liability pressure on the system.  

Equity market

NIFTY could not extend its gains into set sell zone of 5075-5100 and reversed from high of 5020 to 4831 before close of week at 4841; thus trading end-to-end of set weekly range of 4825-5075. In the meanwhile, the expected relief rally in DJIA into 12550-12700 failed at 12611 but reversal from there was sharp (post weak economic data) to crash through strong support at 12220-12200 (low of 12158) before close of week below 12200 which is bearish into the near term. What next? The global bourses will be weak with DJIA set for further weakness into 11875 ahead of 11525 while 12650 stays firm. However, support for NIFTY will be from RBI’s shift into accommodative monetary stance. The shift into surplus liquidity and low interest rate regime will attract investments into equity assets. It is also expected that the Government will act to prevent crisis in the Indian economy. Given these expectations, immediate weakness into 4500 will attract investor appetite. For the week, let us watch NIFTY at 4650-4950 and the focus is back to near term consolidation at 4500-5000. The strategy is to stay invested on immediate weakness into 4700/4550 (with stop below 4500) for eventual test/break of 5000 into 5600 in the short term. The market looks good for providing a 1000 point reward on a risk of less than 100 points.

Commodity market

NYMEX Crude met the short term objective at 83 (low of 82.56); thus completing the chase from 110 providing 25% return in 3 months time since the high of 110.55 seen on 1^st March. Now, it opens up the next target at 75 seen in October 2011. There are no strong cues to look for bullish reversal given the weak global economy, dilution in tensions between Iran and the West and not enough demand to meet supplies. The only bullish factor is the support from QE3 expectation. For the week, let us watch 75-88 with bias into lower end. The strategy is to sell on correction into 85.5-87.5 (with stop at 88.5) for 75.50-75.00.

It was a beautiful rally in Gold from the set support/buy zone of 1535-1525 (low of 1531.5) into the resistance/take-profit zone of 1615-1625 (high of 1626.60) for a bullish weekly close above 1620. The extended rally in USD Index (feeling of over valuation for dollar assets) and QE3 expectations (post weak US Economic data) provided this rally. MARKET PULSE was in preparedness for sharp reversal from 1525-1485 to 1620 and beyond and the rally began from 1527. What next? The ability to take out immediate resistance at 1640 will be critical for quick extended rally into 1670-1680 ahead of 1715-1725 while 1560 stays firm. For the week, let us watch 1560-1680 with test/break either-way to attract. Strategic investors can look to buy back on correction into 1560-1535 (with stop below 1520) for 1680-1715.

I will be away on leave from 2-17th June. Next update on 18th June. Till then, will try to stay in touch through twitter@mosesharding

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

Indian economy: towards 2020 or 1991

Indian economy: Are we on track towards our 2020 aspirations? Risk of turn towards 1991!

The journey so far into FY13 is rough and bumpy. The health of the economy reflects in the exchange rate; rupee is down and weak, highly undervalued despite various measures (and actions) from RBI and most importantly, there is lack of confidence on rupee getting into bullish reversal soon. The expectation on the economy (by most stake holders) is negative: downtrend in GDP growth momentum into 6%; slippage in fiscal deficit into 6% and elevated current account deficit around 4% of GDP. The comfort is from moderation in headline inflation around 6% supported by administered prices on fuel and huge cost subsidisation on food and fertilisers. These expectations obviously do not reflect optimism into the rest of FY13. The monetary dynamics has not yet turned supportive to growth despite 50 bps rate cut and tremendous infusion of liquidity through 125 bps CRR cut and aggressive OMO bond purchases. The system is short of liquidity by around Rs.1 Trillion and money market rates continue to stay at elevated levels; in short, the impact of monetary actions (to support growth) has been ineffective. Why? All the good has been undone through aggressive dollar sales by RBI to defend rupee; shift of credit demand from foreign currency to rupee driven by weak rupee and negative Balance of payment (in the absence of robust capital account flows) resulting in flight of domestic capital. The factors that provide strong headwinds to economic growth (and prosperity) are increasing in the absence of strong remedial measures to provide course correction. There are no positive factors at this stage to act as strong tailwinds; other than the strong India story, termed as giant elephant!

It is not that “powers that be” are not aware of remedial actions. The priority at this stage is on economic reforms to pull off-share investments; cut cost subsidisation to release pressure on fiscal deficit; shift system liquidity from deficit to surplus mode to attract domestic investments (and to release pressure on interest rates) and cut non-essential imports to release pressure on current account deficit (and balance of payments). These four priority actions will address all other woes of the economy to drive optimism into the future. The system is in a stage where it is easier than done. The political structure is weak to roll-out economic reforms and to cut cost subsidisation. Efforts to cut non-essential imports have been reversed in quick time. It is difficult to shift system liquidity to surplus mode till rupee is under pressure. Where we go from here? Is it dead end? The current political structure will stay till 2014. There is no guarantee that people of India will deliver decisive mandate to a political party which can go aggressive on reforms and bite the bullet on cost subsidisation. But, it is a long way to wait for revival; damage by then would be severe and recovery time will be an extended one into 2020. I recollect the dreams that we had in 2000 of turning India into an economic super power by 2020 and now I am afraid we travel back to 1991 where we began the economic liberalisation story. It is scary but not unrealistic and it is high time that “powers that be” take serious note of consequences and deliver remedial actions soon. The Government on its part need to do whatever that is required to attract foreign capital (and liquidity) and address fiscal consolidation through cost reduction. RBI needs to get into aggressive growth supportive monetary stance (may be at the cost of inflation) to drive the system liquidity to surplus mode. These actions are considered essentials to arrest strong bearish set up on asset markets and to revive the optimism on India growth story.

Moses Harding    

Report for 30 May - 01 June 2012

MARKET PULSE: 30 May – 01 June 2012

I will be away from 2^nd June for couple of weeks but will stay in touch with short updates and trading ideas through my blog and twitter@mosesharding........

Currency market

USD/INR extension below the set weekly range of 55.25-55.95 (low of 55.01) could not sustain for strong reversal into the higher end (high of 55.88) before close of day at 55.68; daily close above 55.65 is bearish for rupee. We had considered 55.25-54.80 good to cover short term payables and in any case advised not to stay “short” dollars there. This view is based on expectation of reversal into 55.95-56.40 (driven by USD Index rally into 82.60) where it is good to sell 3M/August dollars and in any case considered not to stay “long” dollars there (from where we saw sharp correction into 55.01). What next? There is tremendous bearish set up on rupee; petrol price hike did provide bit of relief but inability to roll-out price hike in diesel, kerosene and LPG highlighted the weak political structure to address serious concerns on reforms and cost subsidisation. The expectation for FY13 is bearish with risk of slippage in GDP growth and fiscal deficit to around 6% of GDP. There is no need to review the set weekly range and continue to watch overshoot beyond 55.25-55.95 (into 54.80 or 56.40) not sustainable. Let us stick to the strategy of selling August 2012 dollars on spot move into 55.95/56.35 based on hope (and confidence) that RBI would go all out to prevent rupee posting a new all-time low above 56.39; if it does, we may not only see test of 57 (higher end of set short term range of 52-57) but also extension of weakness into 58.25-58.50 ahead of 59.75-60.00 in due course. The combination of weak fundamentals and strong USD (against global currencies) will be deadly against rupee and needless to say, rally of USD against rupee will be much faster than against other EM currencies. Rupee is already undervalued and RBI should prevent further devaluation in the rupee; highly devalued rupee on the back of high inflation, high interest rates and tight liquidity will be very bearish on the Indian economy and it would seriously hurt growth prospects.  The “baby steps” approach (post strong measures on 15^th December 2011) has not yielded results and relaxation in rules on investments into debt capital market for FIIs and/or welcoming new set of foreign investors may not help. It will help when the going is good but not at this stage when there is not a single factor in support of rupee. The low forward premium (3M at 7% and 12M at 5%) will not be considered good to “receive” if expectation is bearish; thus shifting the forward market also into dollar demand-driven mode. RBI has no option but to go “big bang” to provide sharp reversal. For now, let us watch 55.35-56.10 with overshoot limited to 55.10-56.35. It is also critical that USD Index stays below strong resistance at 82.60-82.70 to prevent preparation of momentum for rupee move into new all time low. Fleet footed traders can look to sell at 56.10-56.35 (with stop above 56.40) for 55.35-55.10.

EUR/USD held at the higher end of set weekly range of 1.2250-1.2625 but reversal from high of 1.2624 found solid support above 1.2500 but could not hold to post a low of 1.2461. While we maintain the near/short term outlook for extended Euro weakness into 1.22-1.18, we may need to allow for bit of consolidation at 1.24-1.27 before move into 1.2250-1.2200. EUR/USD will face strong selling pressure around 1.2565/1.2620/1.2660/1.2690 before down into 1.22. The strategy is to stay “short” looking for sharp turnaround from one of these selling points for the said target and to get into new trading range of 1.22-1.25.

No change in view in USD/JPY and EUR/JPY (REFER TO WEEKLY REPORT)

Interest rate market

10Y Bond yield stayed in consolidation mode at 8.50-8.53% with test/break either-way could not sustain. However, weak rupee (and resultant dollar sales by RBI) will provide strong support to Bond market for gradual gains into lower end of set weekly range of 8.45-8.55%. Hold on to “long” entry at 8.53%; add at 8.54-8.56% if seen for 8.47-8.45%.

OIS rates eased into the lower end of set weekly range of 7.95-8.05% (1Y) and 7.45-7.55% (5Y) tracking easy call money market (ahead of reporting Friday) and downtrend in bond yields. The spread between 10Y Bond yield and 5Y OIS rate is steady around 105 bps (midpoint of 100-110 bps range). Let us continue to watch these range as move below the lower end will be short-lived for strong bounce back on shift into new reporting fortnight and ahead of advance tax outflows.

12M FX premium completed the move from 4.90% to 5.60% and reversed sharply to 5% on combination of profit booking, higher spot USD/INR and aggressive dollar sales by RBI. In the meanwhile 3M premium was steady around 7%. The focus is now back to 4.90-5.40% in 12M while 3M premium stays in consolidation mode at 6.75-7.0%. The strategy is to stay paid in 12M at 4.90-4.80% (with stop below 4.75%) for 5.40-5.65%.

Equity market

NIFTY took out strong resistance at 5000 (high of 5020) before close at 4990. It is great comfort to bulls that not only correction from above 5000 is shallow (low at 4982) but the rupee impact is not felt. Let us continue with the set weekly range of 4800-5100 and look for gradual move into upper end (into set sell zone of 5075-5125) before sharply down to 4800 (into buy zone of 4825-4775).

     

Have a great day ahead....................Moses Harding

Weekly report for the week 28 May - 01 June 2012

MARKET PULSE: Weekly report for 28^th May – 01 June 2012

 Special Market Operations or USD Bond issuance – which is the better option?

RBI deployed strong ammunitions to dilute the momentum in rupee fall but could not prevent the “run” into 56-57 (low of 56.39). This is seen as strong support zone for rupee where genuine dollar supplies will come in and would hurt importers to acquire dollars at such high rate; August 2012 dollars above 57.25 and 12M dollars above 60.00 is not a bad hedge for exporters to lock in higher export realisation. The pain (for importers) and gain (for exporters) will shift the forward market into supply-driven mode. This is what precisely happened (to dilute the bearish set up on rupee) and RBI’s physical intervention was effective to guide weekly close at 55.40; one rupee relief from all-time low. So, it validated our belief that rupee should be allowed to find its own floor where lumpy dollar supplies comes into the market while demand is cut. Rupee is not yet out of trouble. The concerns over structural issues stay valid. The domestic issues revolve around policy catalysis and fiscal consolidation. There is no hope at this stage that UPA Government has the power to open up the flood gate to attract external liquidity and capital. There is not much optimism in removal of the fear on policy/reform paralysis. Can the Government work on fiscal consolidation? Government tested the water with petrol price hike (considered as low hanging fruit) but faced stiff resistance from within and outside UPA. The next action will be on Diesel, Kerosene and LPG but the quantum of hike may not be enough to have significant reduction in cost subsidisation. So, there are no bullish cues from domestic sector. The external sector is very fragile with threat of Greece exit from the Euro zone. The “price” that Global Economy pays to keep Euro zone intact is huge. There are no positive signs from here which carries the risk of extended rally in US Dollar against global currencies and dilution in downtrend in commodity prices. Given these factors in play, there is no guarantee that rupee weakness may not extend beyond all time low of 56.39. Rupee could fall beyond immediate support at 56.50-57.00 if USD Index extends it rally beyond 82.60-83.10 resistance zone into 85.25-85.50, pushing EUR/USD into 1.22-1.18. These market developments can put rupee at risk for deeper fall into 58.25-58.75 ahead of 59.50-60.00. RBI should stay prepared to arrest this move.

RBI has two options to guide the rupee back to its realistic value: one, to open up special dollar counter for Oil PSUs and large ticket dollar demand (FCCB/ECB repayments) from other companies. It is fair to provide access to this counter for everyone and not restrict to PSU entities alone. What will be the impact? While RBI may provide dollars on spot delivery basis, it will open up huge demand in the forward market with spot dollar being sold at subsidised rate. The resultant high FX premium will exert upward pressure in MM rates. The “lead” of 3-6M import will generate additional dollar demand of minimum $50 Bio in spot market exclusive of oil PSUs. This can also trigger FII’s exit from debt/equity capital market at subsidised dollar rate. The benefit from this “operation” can provide stability in rupee at 54-55 if RBI is comfortable to run down its dollar currency reserves to USD 200 Billion. The cost of this operation will be huge depletion in RBI’s USD reserves; spike in LAF draw-down to Rs.1.5-2.0 Trillion and the need to provide rupee liquidity through aggressive CRR cut and OMO bond purchases. The end result is that of shift of dollar asset to rupee asset in RBI’s Balance sheet. The cost-benefit seems to be not in favour. The other option is the issuance of sovereign USD bond to NRIs and other eligible foreign investors who have access to Sovereign/Corporate Bond market. The earlier issuance (RIB and IMD) were done when LIBOR was high; now LIBOR is low to keep the coupon rate much lower than the earlier issuances. The impact on RBI’ Balance sheet will be that of creating a USD liability (direct or through a PSU Bank, the bond issuer) and build up of rupee asset through OMOs. The only difference (between the two options) is that of using borrowed USD funds instead of dipping into the reserves with no fear (or risk) of creation of demand for forward dollars. The execution and operation process will be simple providing flexibility to RBI to sell dollars as and when needed...this “fear of unknown” will itself drive the USD/INR pair down to 52-53. So, it seems USD Bond issuance (with equivalent OMO) may be a better option. It will indeed send positive vibes (and great relief) into stake holders and revive investor confidence on market stability; USD/INR around 52.50, 10Y Bond yield around 8.25% and NIFTY into 5600. Isn’t a great feeling? Let us see what is in store?

Currency market

We looked for USD/INR to lose steam at 56.00-56.45 and advised exporters to sell August 2012 dollars at 57.00-57.25; rupee posted an all-time low of 56.38 (August 2012 dollars high at 57.40) and reversal from there held at the door step of support window of 55.25-54.80 (dollar low of 55.24) before close of week at 55.37. The close below 55.65 and above 55.25 is neutral with no clarity on immediate direction. The sharp reversal was triggered by all factors turning in support of rupee. USD Index held below strong resistance at 82.50-82.60; EUR/USD rallied from 1.2495 to 1.2602; RBI’s aggressive dollar sale was effective when dollar bulls were weak and attractive forward dollar pulled in dollar supplies in the forward market. What next? Rupee seems to have formed a strong support at 56.35-56.50 and should stay protected (by RBI) to avoid reinstatement of bearish set up on rupee. On the other hand, till measures are taken to address structural woes it is difficult for rupee to sustain its gains beyond 54.80 (ahead of crucial 54.30). The effort of the Government to cut fuel cost subsidisation provides good comfort. On the assumption that domestic cues will turn neutral in the near/short term, developments in the Euro zone and its impact on USD will be seen as critical to provide directional guidance from now on. Rupee will be at risk if USD Index rallies beyond 82.50 into 85.25-85.50 (and EUR/USD into 1.22-1.18). This will drive rupee beyond 56.38 into 58.25-58.75 and thereafter into 59.50-60.00. Let us consider this as very low probability but keep this in back of our mind. For the week, let us watch consolidation at 55.25-55.95 with overshoot limited to 54.80-56.40. The strategy for importers is to buy 1-2M forward dollars at value below 55 absorbing rupee strength into 54.80-54.30. On the other side, it is good to sell 3M forward dollars at value above 57.00 and 12M forward dollars around 59.50 absorbing dollar strength into 55.95-56.40. Fleet footed traders need to be very alert tracking USD Index; EUR/USD and of course, keeping eyes and ears on RBI. The art of trading this market is to know the trick of “wind surfing” (to wait for the right/big wave to ride and exit before getting consumed by another big wave) and “fishing” (to stay in patience till the market trades close to either end of the set ranges); setting up trades with very low risk but with huge reward in ratio of minimum 1:5. It is better not to be a “boxer” in this volatile market, the chances of getting hurt are more and the punches that hit the target may be few.         

EUR/USD held well at the strong support zone of 1.2525-1.2475 (low of 1.2495) and recovery from there lost steam at strong resistance zone of 1.2600-1.2625 (high of 1.2619); nevertheless it provided good two-way moves for fleet-footed traders. The inability to take out 1.2625 and weekly close at the support zone (1.2515) is neutral to bearish for the Euro.  For the week, let us watch 1.2250-1.2625 with bias into lower end while 1.2625 stays firm; if broken can extend to 1.2775-1.2825 before down. The strategy is to stay “short” with stop/reverse at 1.2625 for test/break of 1.2475-1.2485 which would get the near term focus into 1.20-1.18 in due course.

USD/JPY was in consolidation mode at 79-80 (high of 80.07 and low of 79.20) before close of week at 79.65; as expected gains above 80 could not sustain but did not have the momentum for extension into next target at 78.25. For the week, let us watch 78.25-80.50 with bias into lower end. The strategy is to stay “short” at 80.00-80.50 (with stop at 80.75) for 78.25-77.75. Beyond there, the focus will be on 76.00-75.50 before strong reversal.

We had set EUR/JPY near term target at 102-97 and looked for quick move below 100 into the lower end; as expected reversal from high of 102.12 was sharp to post a low of 99.33 and bounce from there held at immediate resistance at 100.50 (100.32) before close of week at 99.75. Given the weak undertone both in Euro (against USD) and USD (against JPY), the downward pressure is severe on EUR/JPY currency pair. For the week, let us watch 97.00-100.50 with bias into lower end; the pressure is clearly on move below 97 while any upside attempts fail at 102. The strategy is to stay “short” with stop above 100.50 for 97.00-97.25. If stopped sell again at 101.75-102.25 with stop above 102.50.

Interest rate market

Money Market continues to stay tight with LAF draw drawn around Rs.1 Trillion and overnight MIBOR around 8.25%. The FX impact has pushed 3-12M CD rates into 9.75-10.0%; sharply up from recent low of 9.25-9.5% despite delivery of 50 bps rate cut. 1Y Bond yield is also up from 8.20% to 8.35% while 1Y OIS rate up from 7.95% to 8.05-8.10%. What next? Let us look for stability at current levels till RBI continues to release rupee funds to off-set FX impact on MM. For the week, the draw down from LAF will stay below Rs.1 Trillion on lower demand on move into end of reporting fortnight with overnight MIBOR at 8.15-8.25%. Let us watch 1Y Bond yield at 8.25-8.35% and 1Y OIS rate at 7.95-8.05% and test/break either-way not expected to sustain. The strategy is to stay invested in 1Y Bond (and hold as excess SLR); it will be useful when we get into churning of investment book on sharp rally in long bonds.

10Y Bond yield traded end-to-end of set weekly range of 8.47-8.58% before close of week at 8.51% while 5Y OIS nicely edged up from lower end to higher end of 7.40-7.50% before close of week at 7.50%. The stability in Bond market is thanks to weakness in FX market as RBI is expected to conduct its OMOs. Given the strong bearish set up on rupee, RBI is expected to provide dollar supplies in FX market for extended period of time. This also puts off rate cut expectations and more CRR cuts ahead. The directional break-out beyond 8.45-8.60% will be on rupee getting back its strength into its fair value (for push into 8.75%) and issuance of USD Bonds (for sharp rally into 8.30%). 5Y OIS is expected to maintain its 100-105 bps spread (with 10Y bond yield) for consolidation at 7.40-7.55%. For the week, let us watch 10Y Bond yield at 8.45-8.55% and 5Y OIS rate at 7.45-7.55% with test/break either-way not expected to sustain. Fleet-footed traders can play end-to-end of these ranges while strategic players look stay invested in 10Y bond at 8.53-8.58%. Let us also unwind 5Y paid book (entered at 7.40%) at 7.55% with trail stop at 7.45% and look to build receive book on extension into 7.55-7.60%.

FX premium maintained its uptrend; 3M up from 6.75% to 7.1% and 12M sharply up from 4.9% to 5.5% before close of week at 7% and 5.4% respectively; but for RBI’s B/S swaps (to shift spot sales to forward date), it would have been much higher tracking interest rate play. For the week, let us watch 3M at 6.90-7.40% and 12M at 5.25-5.75% with bias into higher end. The strategy is to pay 3M at 6.90-6.75% (for cost reduction through USD sources); hold on to 12M paid entered at 5.0-4.90% and add at 5.35-5.25% with trail stop below 5.25% for 5.70-5.75%.  

Equity market

NIFTY played within the set weekly range of 4775-4975 (low of 4789 and high of 4956) before close of week at 4920; thus trading end-to-end of sell zone at 4950-4975 and buy zone of 4800-4775. The moves in NIFTY more or less mirrored DJIA trading end-to-end of 12300-12600 (low of 12311 and high of 12575) before close of week at 12454. What next? There are more negative cues in play at this stage. The domestic macros are weak; rupee needs strong support from RBI to arrest extended weakness driven by strong USD and limited signs of optimism from the external sector. There is no buying appetite from domestic investors while off-shore investors are nervous keeping close watch on rupee and policy paralysis. However, there is bit of comfort from the efforts of the Government to cut fuel cost subsidisation and RBI’s open support to rupee in the form of Special Market Operations and/or Sovereign USD Bond issuance to NRIs and off-shore investors. Now, it is important that DJIA stays above strong support at 12220-12200 for relief rally into 12550/12700 to support NIFTY above 4775 for extended gains into 5075-5100. For the week, let us watch NIFTY at 4800-5100 and stay neutral on break-out direction. The strategy is to trade end-to-end by buying at 4825-4775 (with stop at 4750) and selling at 5075-5125 (with stop at 5150). The entry level for strategic investors is revised upwards to 4775/4650/4525 in three lots with stop below 4500 for 5600.

Commodity market

Gold is firmly in consolidation mode within the set near term range of 1520-1620; initial rally from 1527 lost steam at 1599 before sharp reversal to 1533 bouncing back again for weekly close at 1573. The strategy to buy dips into 1535-1525 (with stop below 1520) for move into 1600-1620 has worked well. What next? There are good signs of build up of momentum for extended rally above 1620 into 1670 for 100% reversal of fall from 1671 to 1527; resistances on the way at 1599/1616/1640 while reversal below 1550 (into 1530) stays firm. For the week, let us watch consolidation at 1535-1615 with test/break either-way to attract. The strategy is to trade end-to-end by buying at 1550-1535 (with stop below 1525) and selling at 1600-1615 (with stop above 1625).

NYMEX crude could not sustain its move above 93 (upper end of set 88-93 range) and fell sharply from high of 93.06 to 89.28 before close of week at 90.86. The downtrend in NYMEX crude is firmly in place till recovery in global economy is sighted and the bigger comfort is from G3/OPEC support to arrest rally through increase of supplies into the market. The tension between Iran and the West is seen to be out of the radar given other major issues on priority. For the week, let us continue to watch 83-93 with bias into lower end. Our strategy is to hold on to “shorts” entered at 110 for all the way to 75; let us hold on to this with trail stop at 95 and review the same after meeting the immediate objective at 83.50. Fleet footed traders can look to sell at 91.5-94.5 (with stop above 95) for 83.50.

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