Weekly Forex report for 04-08 February 2013

RBI delivered to expectations on rates with 25 bps cut and surprised the market with 25 bps CRR cut but lack of optimism (and confidence) in RBI’s tone (and guidance) drove asset markets into bearish mode. 10Y Bond is down from 7.80 to 7.93 and NIFTY fell from 6100 to 5980. Why? There seems to be “disconnect” between the “fact sheet” and “policy action”. The pre-policy review highlighted elevated twin-deficits as major risk to inflation with added pressure (in the near/short term) from recent price-hikes and higher commodity prices. Against this back drop, RBI revised the headline WPI target of March 2013 from 7.5% to 6.8% with reminder of its 4.0-4.5% comfort zone. However, there was no reference to retail CPI inflation print which is dangerously above 10%. Obviously so, RBI cautioned the stake-holders on the availability of limited monetary band-width to support growth. While RBI delivered to its commitment given in December 2012 mid-quarter review guidance, market stake holders did not expect a hawkish guidance in January 2013 quarterly review. It is difficult to connect such a hawkish guidance with policy easing, hence the post-policy bearish set up on asset markets! With monetary policy out of the way, attention now shifts to Budget FY14. Here again, it is to be seen how the Government will limit fiscal deficit at 5.3% for FY13 and deliver to its promise of 4.8% for FY14. It is less said the better on the Current Account deficit; BRENT Crude is up 15% since November 2012 and “currency-war” in peer economies making things difficult for Indian exporters with the risk of losing market share and top-line sales! Over all, there is lack of confidence on early resolutions to twin-deficits. It would be difficult task to get growth pick-up through policy reforms, attracting large scale investments from resident and off-shore entities. There is lack of optimism at this stage and the focus is on the implementation and execution of recent reforms and much more, not only to attract investments but also to revive core sectors. The expectation of best case scenario of LAF corridor at 6.50-7.50% stays valid and not sure on the timing of next round of 25 bps rate cut!

The impact of policy action may not result in significant transmission in money market rates and yields. MM rate curve in 3-12M tenors across bank deposits, CPs and CDs are already up and would head higher into financial year end. On the other hand, there will be shift of credit demand from foreign currency to rupees. The high FX premium makes it attractive for exporters to borrow in rupees; at current level of 3M FX premium and 2% interest subvention, it is zero cost rupee funding for exporters. The surplus dollars in the system will continue to keep FX premium at elevated levels to retain demand for rupee credit and provide solid support to MM rates. There is very limited chance of easing in MM rates despite cuts in policy rates and CRR. SBI showed the way with token 5 bps cut in its Base Rate highlighting the insignificant price transmission on deposit rates. Over all, RBI would take comfort that moderation in monetary policy has been achieved through 75-100 bps rate cut and 2.5% cut in CRR since April 2012 and would look up to the Government to achieve moderation in fiscal policy and work towards removal of supply-side bottlenecks to ease pressure on headline CPI inflation. What is the impact on markets?

Interest rate market:

10Y Bond yield is up from pre and post policy low of 7.79-7.83% to 7.93% before close of week at 7.90%, thus trading end-to-end of set weekly range of 7.83/7.85-7.93/7.95. The undertone is weak on many counts; aggressive rate cuts is not in the radar in the near/short term, there will be large scale unwinding of excess SLR investments for profit-booking ahead of financial year end, low appetite for fresh bond issuance from RBI, lack of optimism on the ability to contain downside risks on twin deficits and emergence of growth-inflation conflicts in the near/short term. The relief will be from reduced market borrowing from the Government for rest of FY13 as they prepare to cut expenditure to the tune of Rs.1 Trillion and possible support from RBI through OMOs to arrest excessive weakness beyond 7.95-8.0%. For the week, let us watch 7.85/7.87-7.95/7.97 with bias into higher end. The strategy of MARKET PULSE to completely unwind investment book at 7.80-7.83% has worked well; reversal from here has already met the first re-entry level at 7.93-7.95% while preparing momentum for extension into 7.98-8.0%. At this stage expectation of 7.60-7.65% is out of the radar which shall be reviewed post Budget FY14 when we would get better clarity on RBI’s monetary action in its mid-quarter review on 19^th March 2013.

OIS rates sharply up from pre and post policy low of 7.50-7.53% (1Y) and 7.10-7.13% (5Y) into set objectives at 7.62-7.65% and 7.27-7.30% respectively. The expectation of 25 bps rate cut in Q1 of FY14 will resist extension of rally in 1Y beyond 7.65% while not ruling out extended rally in 5Y beyond 7.30% into 7.35-7.40%. For the week, let us watch consolidation in 1Y at 7.55/7.58-7.65% and 5Y at 7.20/7.23-7.32/7.35%. The strategy is to build “received book” at/above 7.65% (1Y) and at 7.32-7.37 (5Y) in anticipation of correction into 7.55% and 7.20% respectively.

FX Premium traded firm to hit 7.5% in 3M and 6.6% in 12M. The undertone is bullish driven by excess dollars in the system as borrowers prefer rupee loans to encash high premium in shorter end. The uptrend in money market rates make it cost efficient to swap FC into rupees. It suits RBI as high FX premium extends support to spot rupee with exporters leading future receivables while importers refrain from acquiring forward dollars at high premium. For the week, let us watch consolidation in 3M at 7.35-7.60% and 12M at 6.45-6.70% with break either-way to attract. The strategy for exporters is to absorb 3M at/above 7.5% (for availing rupee export finance) while inter-bank diverts surplus dollars in its books to pay 12M at/below 6.5% to fund rupee assets. Traders can trade end-to-end but stay paid on dips in 12M for extension into 6.85-7.0% in the near term.

Exchange rate market:

USD/INR ran out of steam at 53.85-53.95 sell window (high of 53.95) and reversed sharply into set near term objective at 52.85-53.10 (low of 53.06) before close of week at 53.20. In the process, value of 3M dollar fell sharply from recent high of above 56.75 (seen on 26/11/12) by 3 rupees after adjustment of 2 months carry. It is also down by more than Rs.2.5 rupees since first week of January 2013 high of 56.35. MARKET PULSE was urging exporters to cover 3-12M receivables on rupee weakness into 55.85 (in November 2012); add to 3M “shorts” at/above 55.35 in the first week of January 2013 and till 53.85 (in the previous week). The strategy was also to unwind “short dollar book” at 52.85-53.10 and prepare to switch sides to build “long dollar book” at 52.60-53.85. It was then considered high risk to stay “long dollars” at 55.10-55.60 and it is now seen not prudent to stay “short dollars” at 52.60-53.10. Rupee has not only outperformed the peers in January 2013 but continued its rally post-monetary policy despite strong bearish set up in Bonds and Equity markets. While concerns from CAD continue to stay valid, rupee got solid support from good supplies from FIIs (into debt and equity market), large ticket equity raising inflows and supply-driven mode in the forward market (due to high premium) despite limited support (to rupee) from rally in EUR/USD. What next? Rupee is seen to have gone into consolidation mode at 52.60-53.60; bias thereafter is for possible break-down into 53.85/54.10 on emergence of bunched up dollar demand and strong resistance in FX premium beyond current levels. 3M forward dollars at 53.60-54.00 (spot at 52.60-53.00) may not attract exporter’s interest while it may look good for importers given the risk of weakness in spot rupee into 54-56 on any bad news or on strong reversal in EUR/USD. On the other side, 53.85-54.10 is strong support for rupee; 12M forward dollars at 57.35-57.60 will attract exporters’ interest. It is also possible that RBI takes into account exporter’s interest to arrest excessive rally in rupee into 52.60-53.10. Taking all these together, consolidation at 53-54 is seen as ideal range to balance inflation impact and exporters’ competitiveness. MARKET PULSE retains its intra-2013 range of 51.35-55.88 with expectation of move into lower end in the second half of 2013. For the week, let us watch consolidation at 52.60/52.85-53.60/53.85; test/break either-way is not expected to sustain for long. The strategy is to unwind “short dollar book” at 52.85-53.10 (with trail stop at 53.40) and build “long dollar book” at 52.60-52.85 (1M dollar at 52.90-53.15 and 3M dollar at 53.60-53.85) with stop below 52.50. Exporters can look to absorb higher FX premium by receiving 1-12M (February/January 2013 at/above Rs.3.25 for 11 months) and await higher spot at 53.85-54.10 by end of February.

EUR/USD traded to the script within the set intra-week range of 1.3400-1.3750 (low at 1.3413 and high at 1.3711) before close of week at 1.3639. Euro derives comfort from extended QE from FED and threat of US rating downgrade with signs of financial recovery in the Euro zone. The undertone is bullish into 1.40-1.43 in the near term while above 1.3500-1.3550 support zone. For the week, let us watch consolidation at 1.3500/1.3550-1.3750/1.3800. Strategic players can retain “long book” with trail stop below 1.3550 for 1.3750-1.3800. It is possible that EUR/USD gets into correction mode from 1.3700-1.3800 into 1.3550-1.3400 before gaining steam for 1.40-1.43.

USD/JPY extended its rally into 93 (high so far at 92.96 with strong weekly close at 92.72) and has met the set target for 2013 at 92-95 ahead of time. It is a one-way run since mid September low of 77.11 posting over 20% gains in 4 months time. Many see this as “currency war” to revive Japanese exports and economy which is stagnant for over a decade, makes sense! But, how far it can go? Extended gains into 95 is possible but would need deep correction from some point at 93-95 into 88-90. Strategic players having unhedged medium/long term imports and/or JPY liabilities can look for hedge of imports at 93-95 and shift JPY liabilities into USD. For the week, let us watch 90.25/91.75-93.50/95.00; momentum is good for extended rally into higher end before sharp reversal.

Equity market:

NIFTY traded to the script of set weekly range at 5980/6005-6100/6125; reversed sharply from post-policy high of 6111 for gradual weakness into 5983 before close of week at 5998. MARKET PULSE post-policy strategy was to unwind investments at/above 6100 for correction into 5980-6005 which has worked well. What next? Despite strong FII interest, domestic investors continue to stay sidelined on uncertain domestic market dynamics. Despite moderation in monetary policy, there is little optimism in the way forward; while the market has priced-in all positive cues of recent actions on policy reforms and fiscal consolidation, lack of optimism on its impact on macro fundamentals is yet to be priced in. With monetary policy out of the way, the next major trigger will be from Budget FY14. The strategy of the Government to cut (or carry-over?) of Rs.1 Trillion expenditure will have its impact on growth and domestic liquidity. The undertone into Budget FY14 will be neutral to mildly bearish bringing 5825-5840 into the radar while 6045-6060 stays firm. For the week, let us watch 5920-6045 with bias into lower end, not ruling out extended weakness into 5825-5850. The strategy is to build “short” at 6035-6060 (with stop at 6085) for 5920-5850. It is also good to reinstate short term investment book with first lot at 5900-5925 while retaining good appetite for 5825-5850.

Commodity market:

Gold traded end-to-end of 1650-1685 before close of week at 1666.50. The cues into immediate term are mixed but undertone is mildly bearish with strong resistance at 1670-1685, but there may not be strong momentum to take out strong support at 1625-1640. However, there is risk of extended weakness in the near term into 1525-1540 on portfolio shift from commodities to bonds and equities. For the week, let us watch 1625/1640-1670/1685 with bias into lower end. Strategic players can retain “shorts” entered at 1680 and add at 1680-1695 for 1625-1640 ahead of 1525-1540.

NYMEX Crude extended its bull run over 97 into 99 (high of 98.24) before close of week at 97.77. The tone is bullish despite one-way run from 85 since mid November 2012, up by over 15% in less than 3 months. The ability to hold above 96.75-97.00 carries higher risk of test of 100.42, high seen in mid September 2012. The bullish tone is from combination of good performance of other asset classes and better growth prospects while tensions in Middle East provides strong support around 95. For the week, let us watch 95/97-99/100.50 with bias into higher end. The strategy is to retain “longs”, add at 96.50-95.50 with stop below 95 for 99.00-100.50. It is considered good to switch sides there by opening up “short” book at 99.50-100.50 with stop at 101.

Written by J. Moses Harding