Rupee heading towards the elusive 70-mark? Macros and technicals suggest it could

US President’s decision to re-impose sanctions on Iran will not only hit the dynamics of the global oil trade, it will also force India to revisit at its ties with the Middle Eastern oil nations.

   

USD-INR at 70 — a new normal can be seen in early 2019. This could sound a little far-fetched at this point, but in continuation of our previous report dated April 24, 2018 — where we had underscored the possibility of steep depreciation towards 67.50 & 68.00 levels, we now highlight the key fundamental & technical factors in this report that could trigger the next leg of up move.

After a protracted period of carry dominated by low volatility, USD/INR sprang to life in the last fortnight, breaking through the crucial resistance of 65.35. The depreciation has been steep since then, making rupee one of the worst performing currencies among EMs. Much of this upmove was on the back of domestic factors.

With broad-based USD turnaround also looking likely, macros and technicals are stacked against the rupee. Now is the right time for treasuries to restratagise and reconsider their hedging options. It is important to be agile to the regime change due to changing macros and avoid getting into the trap of anchoring bias.

US President Donald Trump’s decision to re-impose sanctions on Iran will not only hit the dynamics of the global oil trade, it will also force India to revisit at its ties with the Middle Eastern oil nations. The only option as a solution for this is to switch to rupee trade.

In reaction to this, Crude oil (WTI) jumped sharply above USD 72 mark. Uncertainty as to who will form the government in Karnataka is also weighing on the Rupee.

Our exports have not picked up in line with the strength in the global economy. The recent trade deficit on a seasonally adjusted basis was higher than USD 15Bn. At this rate, the current account deficit for FY19 is likely to be around USD 80-90 billion.

While this is significantly higher than USD 20-30 billion seen in recent years, there are concerns over whether the capital inflows would continue that could fund this CAD. FDI inflows, too, seem to be waning.

Lack of confidence in the RBI policy due to recent flip-flops has seen FPIs withdraw USD 2.2 Bn from the debt markets in just a few sessions.

With US rates heading higher, the capital account flows in FY19 are not expected to be anywhere close to what we have seen in recent times. The last time we saw our BoP in this situation, was in 2013 when Rupee had depreciated from 58 to 68 levels within a very short span of time.

Though the RBI has accumulated significant reserves since then, in terms of coverage of our external debt, the ratio continues to remain the same, which is why any escalation in capital flight from EMs can spook the Rupee. There is no reason why we cannot see a repeat of 2008, 2013 kind of a situation. In early of this month, NDF market was seen trading as high as 66.25 after RBI’s move to relax ECB norms and restrictions on FPIs to hold shorter-term government papers.

But after revision in corporate investment holding limit (Capped at 20%) and a stronger dollar, rupee erased all its gains. RBI announced that they will purchase government bonds worth 10,000 crores on 17th May under open market operations (OMO). This will likely soothe the nerves of the G-sec yield as their auction got partly devolved. By doing so it would sterilize the liquidity it would suck out as a result of intervening in FX market to halt rupee depreciation.

In a scenario of rising US rates and rising domestic inflation, the RBI is expected to hike rates later this year. Current OIS prices are factoring in 2 hikes by end of FY19. Domestic core inflation has been sticky and if inflation surprises further on the upside, the real rate differential between US and India could narrow, resulting in capital flight. The RBI may have to hike rates in order to combat this.

Technically, the DXY has broken through the key resistance at 90.60 and has broken a weekly trend line. This is pointing towards a reversal in the USD Dollar against majors. On the Rupee, break of 65.35 was a significant breakout.

The first major resistance that the market was seeing was 66.65-70 (from where the rupee had gapped down post the UP election results). With that break, there is almost no technical level in sight till the previous high of 68.90. Further higher degree wave will finish its final leg around 70.00 mark.

The spread between offshore and onshore forward points was at its widest in recent times (8-9 paise) indicating massive unwinding of offshore carry positions. Three-month carry to vol ratio has declined significantly but not as much as is usually seen in times of panic which indicates there could be a further strain on the Rupee.

The difference between one month and three-month At-the-money forward or ATMF vols has also declined. Flattening of the vol curve has resulted in steep depreciation in the Rupee in the past of the order of 5-6 percent.

Seasonality chart of Rupee also validates the quote: “Sell in May and Go Away”. Out of past 10 years, Rupee was seen depreciating for 8 times at an average rate of 1.73%. June too has historically been a weak month for Rupee and a rewarding month for USD bulls.

It is important to note the above macroeconomic shifts and recalibrate hedging strategy accordingly. Exporters are advised to tread cautiously while availing USD funding as large MTM (in case of steep Rupee depreciation) can result in LER limits being blocked.

In a situation where US interest rates are heading higher and USD/INR too, it is important to manage the risks associated with long-term USD borrowings as well. For receivables/payables, hedging through options can give better flexibility and an opportunity to participate in case Rupee depreciates steeply.

Exporters can consider buying plain vanilla ATMS puts. Though expensive, it can be richly rewarding if Rupee depreciates steeply from here on. Importers are advised to buy Risk reversals i.e. buy ATMS calls and sell OTMS puts or can even consider hedging outright through forwards with a trailing stop loss strategy.

The threat of known unknowns in the form of trade wars and geopolitical risks cannot be overlooked. The imposition of sanctions on Iran by the US could result in a further rally in crude prices.

Escalation of trade tensions between US and China could possibly be a big negative for the global economy. On the domestic front, political drama in Karnataka will be closely tracked. Therefore, the triggers are in place for an extended move up in USD/INR from current levels and it is important to position appropriately to get the most out of this up move.

Conclusion:

In a nutshell, fundamental factors described exclusively in above report suggest that there is further room for the rupee to depreciate against the US dollar. After breakout above 65.35 levels, we have seen that the USDINR pair is convincingly trading above 2 std. deviation on a weekly basis. There are triggers for the volatility to remain elevated for an extended period of time.

The pair can be seen moving further towards its all-time high of 68.90 by the end of this year and extension of the bullish leg beyond this level could take the pair higher towards 70 mark by a 1st quarter of 2019.

MORE WILL UPDATE SOON!!

See Nifty in 10,500-10,800 range till May-end

We believe the 10,500-10,800 range is likely to continue till the month-end, which coincides with the May settlement.

The Nifty has remained under pressure after testing the 10,900 mark. Call writing was seen at 10,800 which should keep the index below this level for some more time.

The major problem seems to be stock-specific selling pressure, which has been increasing whenever the index slips from higher levels.

Historically, sharp rupee depreciation within a short period has led to a decline in stock markets. However, this time stocks are seeing more selling in comparison to the index. Only certain Nifty heavyweights were able to support the index.

10,500-10,800 range on the Nifty is likely to continue till the month-end, which coincides with the May settlement.

The ongoing result season is also impacting stock moves. Stocks which posts better-than-expected earnings are getting rewarded with strong price performance, a sign that the market is not totally in a bear grip yet.

FII outflows have continued though DII inflows have been supportive. Major outflow is seen in the debt market where outflows have been more than double that of equity markets. This is also leading to higher bond yields and rupee depreciation.

Bank Nifty likely to slide towards 25,500 levels

After outperforming in the past few weeks, the rally in the Bank Nifty finally paused after gaining nearly 1,500 points in just two weeks. The index found it difficult to sustain and move above 26,900, which resulted in a sharp reversal in the index.

Karnataka election cliff-hanger, rising dollar against the rupee and higher global crude oil prices raised concerns about macros, which piled on pressure on the index.

Apart from HDFC and Kotak Mahindra Bank, all major public sector (PSB) and private sector banks witnessed selling. A fresh round of shorts has been seen forming in the PSB pack, indicating limited upside for the index.

Any major bounce should be used to create fresh short positions. As the index has slipped below the crucial support of 26,000, call writers have shifted their positions lower to 26,000 and 26,200 strikes from 26,500 strikes. The only strike where sizeable additions were seen was 25,500 Put, indicating further downside in the coming days if the index continues to hold below 26,200.

The current price ratio (Nifty/Bank Nifty) has been hovering near 2.43 levels. As the Bank Nifty has been outperforming the broader indices since the past few weeks, we feel the index is likely to extend its profit booking trend, which may pull the ratio lower towards its previous support levels of 2.39.

Higher benchmark bond yields in the US weigh on EMs

The risk environment remained adverse for most emerging markets as US yields and crude oil continue to remain at elevated levels. MSCI Emerging Market index is down almost two percent last week.

Weaker currencies, as well as risks over rising debt, led to profit-booking in EMs. US treasury yields tested the 3.11 percent mark, the highest since 2011, on the back of rate hike prospects.

Sharp equity outflows were witnessed in EMs - South Korea ($572 million), Malaysia ($375 million) and Indonesia ($193 million) - last week. Taiwan was the outlier with inflows of over $188 million.

Korean peninsula concerns linger as North Korea has threatened to pull out of scheduled historic meet between US President Donald Trump and North Korean leader Kim Jong-un over a US-South Korea’s joint military drill.

In futures and options, some short closure was seen in options segment, in the run-up to Karnataka state elections. Domestic inflows to the tune of $450 million, however, remained intact, helping to limit sharp declines in equities.

Domestic yields have retraced from about 7.92 percent levels to 7.81 percent at present. Higher yields have also led to sharp outflow redemptions from domestic debt segment.

Venezuela election outcome, as well as move in crude oil prices, remain factors to be watched out in the near-term. Any decline in crude oil prices could weigh on the dollar as well as provide support to emerging market debt.

Rupee roils over Karnataka political turmoil

The Dollar index tested its highest levels in 2018 as rising US 10-year bond yields and relatively less hawkish major central banks supported the dollar versus other major currencies. The US 10-year benchmark treasury yields tested 3.11 percent last week, its highest since 2011.

The euro lost sharply against the dollar losing almost 1.17 percent while the Japanese yen lost almost 1.42 percent. EUR:USD is at the supports of 1.18 level while JPY:USD could decline till 112 as the Bank of Japan remains one of the last major central banks continuing its accommodative monetary policy stance.

The rupee extended its losses for the sixth straight week against the dollar, falling below 68.10 levels, its lowest since January last year. USD:INR has supports near 67.70, while 68.50 is a crucial near-term resistance. Any decline in crude oil prices could see some recovery in rupee losses.

MORE WILL UPDATE SOON!!

BSY's exit, crude may take Nifty to 10,400; here’s where you should park your funds

Investors are advised to stick to companies with stable, steady and visible earnings growth.

  

Political drama emerging out of Karnataka as well as boiling crude oil prices, which are hovering near the $80 a barrel, are enough to take the Indian market lower. The latter has already plunged over 300 points from the recent highs of 10,930 recorded on May 15.

The market might have factored in a non-BJP government in Karnataka to some extent but worsening macros is something which might have larger ramification for markets, experts suggest.

The incumbent Chief Minister for two days, BS Yeddyurappa resigned from his post on Saturday and the governor invited Congress-Janata Dal (Secular) alliance to form the government. HD Kumaraswamy will be sworn in as Chief Minister of Karnataka on May 23.

Expects markets to open negative on Monday. Worsening macros as well as opposition unity can have an impact on markets. The Nifty which has already broken key support levels last week could well head towards 10,400 levels in the next two weeks.

A slip towards 10,400 from current levels translates in a fall of nearly two percent, or about 200 points, from current levels. “Mid and smallcap stocks are already facing the heat and over 250 stocks hit a fresh 52-week low on Wednesday. Hence, the market could remain under pressure for some more time.

Commenting on the ongoing fall in the markets which resulted in the Nifty breaching 10,600 levels, Ajay Bodke, CEO and Chief Portfolio Manager PMS at Prabhudas Lilladher, said as the Bharatiya Janata Party (BJP) failed to prove its majority in Karnataka, the sharp correction that is underway is likely to gather momentum.

Investors are advised to stick to companies with stable, steady and visible earnings growth in sectors such as retail-focussed private banks, fast moving consumer goods (FMCG), retail, and automobiles. Investors need to tread with caution in sectors such as aviation, logistics, oil marketing companies (OMCs) and tyres.

Oil prices fell on Friday, but Brent crude marked its sixth straight week of gains, boosted by plummeting Venezuelan production, strong global demand and looming US sanctions on Iran, a Reuters report stated. Brent crude futures fell 79 cents, or one percent, to settle at $78.51 a barrel. The global benchmark on Thursday broke through $80 a barrel for the first time since November 2014.

Impact of the Karnataka political outcome will be short-lived. This is unlikely to impact the prospects of the National Democratic Alliance (NDA) in the 2019 general elections. Of immediate concern to the market will be the impact of crude at $80/bbl on inflation, interest rates, exchange rate and the GDP growth rate.

The market upside capped with the macros turning unfavourable on account of the crude spike. “If crude continues to rise and crosses $85, there will be a sell-off in the market. Otherwise, the market will remain rangebound.

The recent sell-off in small and midcaps will continue for a few more days due to the mutual fund restructuring. This will also provide opportunities to buy some quality small and midcaps.

As many as 168 stocks on the NSE hit a fresh 52-week low on Friday. These include: Crisil, Ceat, ACC, ABB India, Jet Airways, Bharti Airtel and DB Corp. On the BSE, as many as over 250 stocks hit a fresh 52-week low including: Ajanta Pharma, KPR Mills, Strides Shasun, Cadila Healthcare, LIC Housing Finance, and Tata Motors.

Technical view

The Indian equity market fell for the fourth consecutive session on the backdrop of political uncertainty, and deteriorating geopolitical climate, and rising crude prices.

The Nifty took a breather despite a positive opening on Friday and fell below its crucial support of 10,650-10,600. It closed at 10,596, down about two percent on a weekly basis.

With a negative breakout from its short-term moving average, the index formed a long bearish candlestick pattern on the daily price chart, indicating sustained pressure for the index. It signalled negative strength from the secondary indicator, with its weekly RSI slipping to 55 levels.

The market breath is in a negative trajectory. “Rising crude oil prices may lead to inflationary pressures for the domestic economy. Coupled with the weakening of rupee against the dollar and the political scenario in Karnataka, overall market breadth is currently in favour of a negative trajectory.

The index remaining range bound with a negative bias on a weekly basis at 10,670 levels on the upside and at 10,510 on the downside.

MORE WILL UPDATE SOON!!