Global economies in fiscal crisis: Moses Harding
It is fiscal crisis in developed economies and some of the emerging economies (especially in India). It is difficult to make both ends meet when growth momentum is under pressure; revenues will be squeezed while it is difficult to cuts costs, thereby widening the fiscal gap, says Moses Harding, IndusInd Bank.
Global economies in fiscal crisis.......extended delay in growth recovery to haunt markets
It is fiscal crisis in developed economies (especially in the US and Euro zones) and some of the emerging economies (especially in India). It is difficult to make both ends meet when growth momentum is under pressure; revenues will be squeezed while it is difficult to cuts costs, thereby widening the fiscal gap. It is also difficult to bridge revenue gap through higher taxes while cutting unproductive expenses will not be populist. It may not be prudent to cut productive expenditures or investments when growth is under pressure; cut in public investments will also push private investors into risk-off mode. It is a vicious trap which US and Euro zones are unable to get out of it. The western economies are already in very loose monetary policy to spur consumption and investments but its beneficial impact on growth and employment is not yet felt despite low inflation, negative real interest rates and the Governments and Monetary authorities walking in the same direction. On the domestic front, the crisis is worse with elevated inflation generating conflict of interest between the Government and RBI. After series of action from the Government towards addressing fiscal crisis, there was expectation of rate cut action from RBI. Though, the market was seen to be divided in rate cut expectation, the post-policy reaction do not suggest this. The 10Y Bond yield was up sharply from 8.11% to 8.22%, 1Y OIS rate up from 7.55% to 7.80% and 5Y OIS rate up from 6.95 to 7.15%. So, most market participants if not all, expected or positioned for rate cut action. The impact on rupee is severe; down from 53.75 to 54.80 on a deep correction from recent high of 51.35. The equity market fared better; initial weakness into 5580 was followed by rally into 5780 on value buying from off-shore investors but momentum could not be held for correction into 5680. The consolation is from clear signals of rate cut action in January-March 2013 and thereafter prepare for shift of system liquidity from deficit to surplus in July-December 2013.
The markets will remain choppy and weak till resolutions to fiscal crisis are out of the way. The Obama administration has tough task ahead to avert fiscal cliff; not clear at this stage, how he is going to achieve without tax hikes and cut in unproductive expenses. The same is the case in the Euro zone; PIIGS countries can give shock while Germany and France are under severe growth pressure. The comfort is from the efforts to hold the Euro zone together. On the domestic side, soft commodity prices would help but weak rupee stays spoil-sport. There is not much of pressure on the revenue side so far but addressing cost side with limited political support is an issue. The market will watch closely on the ability to raise money through disinvestments and other one-off items from sale of unproductive assets. It seems India is better positioned in addressing fiscal crisis than the developed economies. The major concern is from elevated inflation and possible delay in RBI’s shift to growth supportive monetary stance; need is to maintain operative policy rate at the lower end of LAF corridor, the Reverse Repo rate to spur growth, consumption, investments and remove supply-side bottlenecks. Over all, near term uncertainties continue to remain valid with no confirmation on sighting the light at the end of the tunnel. It is difficult at this stage to take short/medium term bullish outlook on lack of confidence on fixing fiscal issues and limited ability to get growth momentum back on track. What is the impact on asset markets?
Rupee is sharply down from 5th October 2012 high of 51.35 (into 54.80) wiping out 58% of its recovery from historic low of 57.32 (punched on 22nd June 2012). During this period USD Index is up from 78.60 to 81.00 i.e., while the dollar is up by 3%, rupee is down by 6.7%. So, rupee woes are from combination of domestic and external cues. The domestic woes from issues relating to twin deficits and conflict in growth-inflation dynamics remain valid with risk of delay in resolutions till the Government and RBI walk in the same direction. Rupee is now seen as the most underperforming currency against its peers; it is not good for the pride of the Indian economy. What next? The dilution in bearish set-up on rupee will be from further downtrend in commodity prices, sustainable off-shore liquidity flow into debt and equity capital market and favourable monetary conditions triggered by downtrend in headline inflation. These conditions will lead to rupee outperformance against peers and dilute dollar bullish impact on rupee. It is also essential for USD Index to fail ahead of key resistance at 81.35 to remove pressure on rupee. What is in our control is to roll-out investor friendly policies and swift shift into growth supportive monetary environment. For now, let us watch next solid support for rupee at 55.00-55.10, risk of extended rally in USD Index into 82.00 will bring rupee focus into 55.60 ahead of 56.00-56.10. It is also important for rupee to take out immediate resistance at 54.30 for extension into 53.40-53.65. Despite the need to maintain stability in rupee exchange rate with bullish undertone to attract off-shore inflows and contain inflationary pressures, excessive weakness in rupee will delay improvement in macroeconomic stability; will look up to RBI for ensuring this. For the week, let us watch 54.30-55.10 and stay neutral on extension into 53.60 or 55.60-56.00; will have close watch on price action in USD Index at 81.35 and 80.20 for this directional breakout. The strategy is to trade end-to-end of 54.30-55.10 with stop/double reverse on break thereof.
Euro is down into lower end of set strong short term base at 1.2650-1.2750 (low so far at 1.2691). It is important for Euro to hold above 1.2650 to retain its short term bullish undertone; else, extended weakness into 1.2475-1.2500 will come into play. The immediate resistance at 1.2785-1.2800 has to be taken out to bring Euro bulls into street for further extension into 1.2875-1.2900. While ECB maintained “no rate cut” stance, there is build up of 25 bps rate cut which is keeping Euro under pressure. The “fiscal cliff” in the US has retained investors’ risk-off mode to add strength to the US Dollar. There is no clarity either-way at this stage but will keep the bias open for reversal in recent sharp fall in the Euro from 1.3169 to 1.2689. For the week, let us watch 1.2650-1.2900 with bias into higher end. The strategy is to trade end-to-end with stop/double reverse on break thereof. The earlier outlook for Euro strength into 1.3070-1.3170 stays valid.
USD/JPY traded perfect to the script; rally from 77.40 met the set objective at 80.65 and reversal from there met its target at 79.40-79.15. What next? USD/JPY has to hold above 78.85 to retain its bullish undertone for extension beyond 80.65; else deeper correction into 78.00-77.85 will come into play. For the week, let us watch consolidation at 78.85-80.65 and stay neutral on break-out direction. The strategy is to trade end-to-end with stop/double reverse on break thereof.
The smart rally in NIFTY from set short term base at 5580 lost steam at 5780 ahead of set objective at 5800-5830; correction from there found support at 5680 for weekly close at 5686. The monetary policy jitters could not do much harm to equity market on good appetite from foreign investors. It would need strong domestic cues for extended bullish undertone beyond 5780-5830 while 5630-5580 stays firm. There is good value buying seen at 5630-5580 to retain bullish undertone into short term. For the week, let us watch 5630-5780 with extension limited to 5580-5830. It is traders market and considered good to buy at 5630-5580 and sell at 5780-5830 with tight stop on break thereof. There is no change in expectation of extended rally into 5980 on signals of monetary easing from RBI.
Gold has traded to the script; up from set buy zone of 1680-1665 (low of 1672) to meet set objective at 1735-1750 (high at 1738). What next? The growth concerns on the Global economy will add strength to Gold in the near term; thereafter possible resolution to the “fiscal cliff” and resultant shift into risk-on mode will extend rally in Gold. It is possible that Gold has already seen a near/short term base at 1672 for bull-run into immediate objective at 1790-1800. For the week, let us watch 1715-1765 with bias into higher end, and prepare momentum for extended gains into 1790-1800. The strategy is to buy dips into 1720-1695 with tight stop for set objectives at 1765-1790.
The reversal target in NYMEX Crude from above $100 (high of 100.42) is just short of final objective at 82.50-77.50 (low so far at 84.04). The bulls are already down and out on lower demand and efforts to be less dependent on imported CRUDE. The next objective is at 82.25 ahead of 77.30 not ruling out further extension into 75. This expectation is valid till 88-90 stays firm to set up near term trading range of 75-90 with bias into lower end. For the week, let us watch 77.50-87.50; strategy is to sell in two lots at 86.50-87.50 and 89-90 with tight stop for 77.50-75.00.
Interest rate market
10Y Bond yield traded end-to-end of set “inner ring” of 8.17-8.22 (within the “outer ring” of 8.15-8.25%) before close of week at 8.22%. The undertone into near term is bearish driven by week-on-week auction supplies, risk of overshoot in market borrowing and fear of cut in HTM limit from 25% to 23%. On the other hand, rate cut expectation in January-March 2013 provides support. There is strong debate on the need to have HTM retention limit at 25% while SLR limit is 23% with availability of refinance from RBI Repo counter for over 23%. RBI may “time” the cut in HTM limit along with rate cut actions to prevent extended weakness in 10Y Bond yield above 8.25% and arrest excessive gains below 8.10% to build time value between overnight rate and 10Y Bond yield; overnight rate at 7.50% and 10Y Bond yield at 8.10% will look alright. This sets up short term range play at 8.10-8.25%. For the week, let us watch 8.17-8.25% with bias into higher end. The strategy is to stay invested at 8.23-8.25% for 8.18-8.17%. It is possible that RBI would open its OMO window on extended weakness beyond 8.25%. It is also good time for Banks to fill shortfall in HTM for good yield pick-up.
OIS rates too traded end-to-end of set range of 7.72-7.80% (1Y) and 7.07-7.15% (5Y). It was also considered not safe to stay “paid” on test/break of higher end; test/break there could not sustain for close at 7.77% and 7.14% respectively. Now, focus will shift into 1X5 play; while 1Y is expected to stay below 7.80%, there is risk of extension in 5Y into 7.20% to cut 1X5 spread to 55-50 bps (from current 63-65 bps) into near term. For the week, let us watch 1Y at 7.70-7.80% and 5Y at 7.10-7.20%. The strategy is to stay received in 1Y at 7.80% (for gradual move into 7.70%) and pay 5Y at 7.12-7.10% (for 7.18-7.20%).
FX premium has nicely settled into trading range within 6.25-6.75% (3M) and 5.35-5.75% (12M); bullish momentum into higher end is arrested by strong exchange rate play while there is strong support on the lower end from interest rate play. The risk of test/break of higher end will be on sharp reversal in USD/INR from 54.80-55.10; break here (into 55.60-56.10) will trigger test/break of lower end. For the week, let us watch 6.15-6.65% (3M) and 5.4-5.7% (12M). The strategy is to trade end-to-end with tight stop on break thereof. It will be good to stay paid on test/break of lower end for ALM play and interest arbitrage for importers.
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