>STRATEGY – With Crude’s decline, expect short-term rally to continue…

Executive Summary
We can all breathe a sigh of relief as last week’s events have come to an end. If we look at the past week in hindsight, key negative risks such as Greece’s exit from the Eurozone have clearly been avoided, which has been enough to calm frayed nerves in the markets. Similarly, in the US, the Fed extended its Maturity Extension Program (MEP), or Operation Twist, by $267 bn and assured markets that more will be done if required thus expanding chances of another round of Quantitative Easing. Thus, things on the global side played out in the favor of bulls. On the domestic front, the RBI delivered a surprise by keeping policy rates and CRR unchanged, contrary to market expectations.


The joker in the pack, however, has been crude oil. Brent crude has dropped to $90/barrel on global growth concerns and a 22-year high stock pile in the US. The fall in crude prices has become one of the biggest game changers for India with its ramifications pretty strong on account of our twin deficits.


On the political scenario, the Prime Minister has taken up the Finance portfolio as Mr. Pranab Mukherjee resigned to contest for presidential elections. This raises some hopes that the PM will act once again as he had done in 1991. Thus, any strong move could have a strong signaling effect on the markets.


Technically, we are well placed above 200 DMA. The recent fall in crude oil prices coupled with strong technical indicators suggest that the current rally may extend to previous highs of 5,500. Hence we recommend trading on the long side in the next 3 to 6 weeks.


Recent events - No complaints as negatives avoided
Greece election results helped restore some calm in the markets with the New Democratic Party (NDP), Pasok and the Democratic Party of the Left forming a coalition government with a total seat count of 179 out of 300 (60%). Thus, the near-term fear of Greece moving out of the Eurozone has been put to rest as the new government realizes the importance of its existing Eurozone membership. This is the outcome that markets wanted to see as the new coalition has generally signaled a willingness to go along with the current bailout path and not buck the rest of Europe.


The Federal Reserve, too, did not deliver any major surprises as it announced a continuation to its MEP (Operation Twist) to the tune of $267 bn. Further, the Fed decided to keep the target range for federal funds rate at 0 to 0.25% and exceptionally low levels for the federal funds rate at least through late 2014. The Fed’s acknowledged that the US economy is expanding only moderately and that growth in employment has also slowed in recent months, keeping unemployment rates elevated. The Fed’s assurance that it will be ready to support the market as needed however lends assurance of another round of QE in the near term.


The RBI, meanwhile, in its June 2012 mid-quarter monetary policy review maintained a status quo on repo rate and CRR at 8.0% and 4.75%, respectively. This move was made in contrast to both our and market expectations of 25bps reduction in policy rates. The Reserve Bank cited concern on inflation and shifted the blame of slower investment growth on the government and other reasons. It is interesting to note that RBI once again has shifted focus on headline inflation rather than the more encouraging core inflation number and going forward monsoon’s performance will play a pivotal role in determining headline inflation trends.


Crude comes to the rescue
The joker in the pack has definitely been crude oil. Brent crude has fallen to $90/barrel on global growth issues and a 22-year high stock pile in the US. The fall in crude prices has become one of the biggest game changers for India, with its ramifications pretty strong on account of our twin deficits. The current account is sensitive by 45bps for every $10/barrel move in crude and crude’s decline from $120/barrel to $90/barrel means that we can now expect CAD at 2.5% in FY13 if crude ends the year averaging at $90/barrel. On the fiscal account as well, a decline in crude helps bail out the central government as they continue to struggle to push a hike in diesel prices. Further, even adjusted for a fall in Rupee, domestic cost of fuel has declined by over 10% since January. This lends some comfort to OMCs given that they have been unable to hike diesel prices.


To read report in detail: STRATEGY


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