Weekly Report (14th January, 2024): Rupee shows signs of breaking range, strengthens to end week below 83 mark

*US treasuries rally, rate cut expectations intensify despite higher than expected CPI.

*Less than feared impact on IT earnings propels Nifty to all time highs.

*US and UK launch strikes against Houthis in Yemen in retaliaton to attacks on cargo ships passing through the red sea. 

The key data print in the week gone by was the US December CPI. Despite the higher than expected CPI (actual 3.4% Vs 3.2% yoy expected) and core CPI (actual 3.9% Vs 3.8% yoy expected), we have seen US rates come off. As supply side woes seem behind us, there is a growing feeling that Fed will start normalizing rates from current elevated levels. Also rent, which is one of the components of CPI that was responsible for the higher than expected print, has a much lower weightage in the PCE which is the Fed's preferred inflation measure. Also, US Producer prices came in lower than expected at -0.1% MoM (1% yoy)

The probability of a rate cut in March has risen to 81% from around 70% last week. The market is seeing an 87% chance of the Fed funds rate being in 3.25-4% by the end of 2024 which implies 6 to 8 cuts of 25bps each. 

China December CPI and PPI indicated that China continues to face deflationary pressures. 

Price action across assets

US 2y yield dropped 25bps this week to 4.14% while 10y yield fell 11bps to 3.94%

The dollar has been quite steady against the majors. Yen weakened this week despite a dip in US yields. Overall, given the buoyant risk sentiment and falling US yields, we are biased towards Dollar weakness for the coming week. 

S&P500 advanced 1.8% and is close to all time highs while Nasdaq rose 2.8% this week. 

Brent ended the week at USD 78.2 per barrel while Gold ended at USD 2050 per ounce. We could see the oil prices soften as US and UK strikes in Yemen would deter Houthis from blocking maritime traffic through Red Sea. Iron ore prices softened by 3% this week while Copper fell 1.7%

Domestic Developments

Dec CPI print came in lower at 5.69% against the expected 5.90%. On the other hand, Core CPI eased to 3.77%

IIP rose just 2.4% yoy in November. A slowdown in consumer durable output is a concern. 

FX Reserves dropped USD 5.9bn to USD 617.3bn as of the week ended 5th Jan

Equities

Nifty ended at an all time high of 21894 helped by a strong performance of IT stocks on better than expected Q3 earnings report. The IT index rose 5% on Friday. Nifty P/E on a TTM basis stands at 23.3. Broader markets are showing some signs of fatigue at current valuations. FPIs have poured in close to 0.5bn in domestic equities in the first few sessions of January. 

Bonds and Rates

FPIs have poured in close to USD 1bn in domestic debt in January so far. Yield on the benchmark 10y ended at 7.18%. 1y and 5y OIS ended at 6.63% and 6.20% respectively. We continue to feel that these are excellent levels to add duration to portfolio. Liquidity in the banking system continues to remain in deficit mode. Overnight call fixings have been happening around 6.85%

USD/INR

The rupee strengthened this week to end at 82.92. We have been highlighting that the overall flow pipeline and BoP picture look quite rosy and that if the RBI lets off its firm grip, the adjustment in USD/INR is mostly likely to happen on the downside. 

1y Forward yield crept higher to 1.90% while 3m ATMF implied volatility was mostly flat at 2.86%. 

If Rupee sustains below 82.90, we could see a move lower to 82.40 over the next couple of weeks. We expect a 82.60-83.15 range over the coming week. A close above 83.15 would invalidate this view. 

Key Data & Events in the coming week

Tuesday: UK employment data, German ZEW economic sentiment and current situation

Wednesday: UK Dec CPI and US Retail sales

Friday: UK Dec Retail sales, US Jan Michigan consumer sentiment, US Dec existing home sales

Expected Ranges & Bias

EUR/USD 1.0870-1.1050 with up side bias

GBP/USD: 1.2650-1.29 with up side bias

USD/JPY: 142.50-145.50 with down side bias

USD/INR: 82.60- 83.15 with down side bias