December 08, 2010 Global Markets Group

Daily update for 08 December 2010

Money Market & Government Bonds:

Overnight MIBOR eased to 6.75% (against previous 6.87%) despite steady draw down
from RBI at Rs.1.18 Trillion. Term money rates continue to stay at elevated levels with
bit of inversion between 3M and 12M rate curve (3M money at 9.10-9.20% and 12M
money at 8.90-9.10%). This highlights confidence on expectation of reversal trend soon
with all stake holders in “borrow short – lend long” syndrome. RBI’s supportive actions
did cool down the bond yields but initial gains into 7.98% (7Y); 8.07% (10Y) and 8.13%
(12Y) could not sustain for close at 8.04%; 8.10% and 8.19% respectively.

The bearish sentiments stand diluted and investor confidence has improved but the
market is bit uncertain on tough days ahead to face advance tax outflows in mid
December. There is great comfort from RBI to release rupees into the system through
outright spot dollar purchases (to cushion run-away rupee gains) and B/S swaps (to
arrest FX impact on money market through higher FX premium) to provide sufficient
liquidity into the system without the need to cut CRR/SLR. So, let us not get too much
worried on liquidity front. It is just matter of time before system cash shortage drops
below Rs.25-50K Crores to guide overnight MIBOR reversal into the Repo rate (and then
into LAF corridor). Given this expectations ahead, the current higher yield is good for
strategic investors enjoying decent “carry” (through CBLO/LAF) till sighting of clear
trend reversal. The target for end December is set at 7.90% (7Y); 8.0% (10Y) and 8.05%
(12Y). For now, let us watch 7Y at 7.98-8.05%; 10Y at 8.05-8.12% and 12Y at 8.10-
8.22%. For those who missed the earlier opportunity to lock into higher yields, it is
another chance to stay invested ahead of OMO when RBI is expected to provide clear
signals for reversal in 10Y benchmark yield to 8%. The trade recommendation
therefore is to buy 7Y 7.99% 2017 at 8.05-8.09% (with stop at 8.11%) and 12Y
8.13% 2022 at 8.20-8.24% (with stop at 8.26%) for immediate objective at 7.98%
and 8.10% respectively. The cut-off yield and sharp fall in draw down from RBI (and
the resultant ease in call money rate into 6.35-6.50%) will be the triggers for this move.
Keep close watch on RBI’s actions in FX market to feel the release of cash into the
system.
Overnight Index Swaps (OIS):

The initial reversal into 6.85% (1Y) and 7.38% (5Y) could not sustain for close at 6.93%
(against previous close of 6.92%) and 7.45% (against previous close of 7.46%) to play
end-to-end within the set ranges of 6.85-6.95% (1Y) and 7.35-7.45% (1Y).

It is yet another opportunity (for those who missed the earlier move) to build “received
book” in 5Y at 7.45-7.48% and now extended rally in 1Y rate over 6.90% looks too juicy
to miss. Given the very high probability of easing of overnight MIBOR into 6.35-6.50%
(with near zero risk of spike over 6.90%), it is too good for call lenders to lock the yield
at current level and on spike over 6.95%. There is nothing in store to look for extension
of this weakness beyond 7% (1Y) and 7.50% (5Y). The impact due to advance tax
outflows will be minimal as RBI would have pumped in enough liquidity (through its
actions in FX market) to cover this outflow from the system. For today, let us watch 1Y
at 6.83-6.98% and 5Y at 7.38-7.48%. The initial weakness into higher end should
not sustain for sharp reversal into the lower end and prepare for test/break
thereof. The trade recommendation is to receive 1Y at 6.94-6.99% (with stop at
7.01%) and 5Y at 7.45-7.49% (with stop at 7.51%) for end December target at
6.75% (1Y) and 7.25% (5Y).

USD/INR SPOT:

The set objective at 44.65 is met in quick time as rupee rallied to 44.64 despite RBI’s
strong defense (to greenback) before close at 44.65. This has weakened the March 2011
dollar to 45.58 (from sell zone at 45.90-46.00; high of 45.94) and 12M dollar into 47.08
(from sell zone of 47.95-48.10; high at 48.13). In the meanwhile, EUR/USD played end-
to-end within 1.3250-1.3400 and SENSEX in consolidation mode within 19850-20000.
We had also asked importers to stay away for move into 44.65-44.50 to hedge 1-2M
payables and market did provide a quick dip into this zone. There were no clear signals
on break-out direction of EUR/USD from its consolidation mode within 1.3250-1.3450;
hence was the call to hedge near term payables (at 44.65-44.50) having covered exports
on weakness into 46.10.

Now, it is time for importers to take away the “greed” factor to cover 1-2M payables at
44.65-44.50 keeping room for adding at 44.35-44.20 as sharp reversal from 44.20 to
45.00-45.50 is not ruled out. Rupee has already recovered 68% of the fall from 43.97
(seen on 15/10) to 46.11 (seen on 30/11) in record time of 7 trading days. The next
strong support is at 44.42-44.48 ahead of 44.35 before completion of 100% recovery at
43.95-44.00. We also need to watch strong support for 12M forward dollar at 46.95-
47.00 with the next solid one at 46.50. It is prudent for exporters to unwind 12M hedge
in two lots at 47.00 and 46.50 (enjoying the short time decay). In the meanwhile, let us
adjust the EUR/USD range to 1.32-1.34. There seems to be not enough momentum for
test/break either-way. This would guide rupee in two-way consolidation mode within
44.65-44.85 but given the mild bias towards test/break of 1.3400 (for extended move
into 1.3450 before reversal), extended rupee gains into 44.45-44.50 not ruled out. Over
all, let us watch near term range play within 44.65-44.85 with extension limited to
44.50-45.00. The exchange rate risk management strategy is to cover 1-2M payables on
entry into 44.65-44.50 and to hedge 1-3M receivables on weakness into 44.85-45.00. For
today, let us watch rupee at 44.65-44.80 and track EUR/USD at 1.3200-1.3400 and
SENSEX at 19850-20000. Given the consolidation mode in domestic stock market
and in EUR/USD, rupee should stay boxed within 44.70-44.80. The immediate term
bias is mixed and hence stay prepared for move either-way within 44.65-44.85.
The trade recommendation therefore is to sell in two lots at 44.75-44.78 and
44.81-44.84 (with stop at 44.87) and to buy in two lots at 44.68-44.65 and 44.62-
44.59 (with stop at 44.55).

USD/INR Premium:

Despite mild reversal in interest rate play, exchange rate play (lower USD/INR into
44.65) pushed premium higher to the set objectives at 7.0% (3M); 5.5% (12M) and 5.0%
(3X12M) before close at 6.95%; 5.45% and 4.95% respectively. The reversal from the
recent low of 5.75% (3M); 4.4% (12M) and 4.25% (3X12M) has been rather sharp and
swift.

What next? There is no change in views as premium should stay within 6.75-7.0% (3M)
and 5.25-5.50% (12M) in consolidation mode. Given the expectation of interest rate
peaking out by mid December and rupee in two-way consolidation mode within 44.50-
45.00, the bias is test/break of lower end in due course into 6.5% (3M); 5% (12M) and
4.5% (3X12M). For the day, let us watch 3M at 6.75-7.0% (S/Feb at 66.25-68.75)
and 12M at 5.35-5.50% (S/Nov at 232.75-239.5) with initial move into the lower
end should hold. The trade recommendation is to receive 3M at 7.0-7.15% (S/Feb
at 68.75-70.25) and 12M at 5.50-5.60% (239.5-244) with stop above 5.65% (246).
Let us now watch RBI shifting its focus from spot market to forward market to inject
rupee liquidity into the system through B/S swaps.

Stock Market:
It was consolidation within 19850-20000 (5950-6000) with test/break either-way could
not sustain for close at 19934/5976 down by 0.25% against previous close of
19981/5992.

Let us continue to look for consolidation in the near term with mild weak undertone for
gradual weakness into 19680/5900 ahead of 19500/5850. This support is expected to
hold good for gaining momentum for test/break of 20000/6000 for short term target at
20500/6150. Over all, stock market is expected to stay within 19500-20500 (5850-
6150) till end of December 2010 and await fresh cues on shift into New Year to provide
clear directional guidance. For today, let us watch consolidation within 19850-
20000 (5950-6000) with mild bias towards test/break of 19850/5950 for
19680/5900. Strategic investors can await this mild correction into 19680-19500
(5900-5850) with stop below 19450/5830. In the current market scenario, extended
gains over 20000/6000 should stay limited to 20150/6040 ahead of 20350/6100. Fleet
footed traders can sell in two lots at 20100-20150 (6025-6040) and 20250-20300
(6070-6085) with stop above 20350/6100.

Moses Harding
Executive Vice President
Head – Global Markets Group
IndusInd Bank, Mumbai

moses.harding@indusind.com
+91-9820334145