IFA GLOBAL TREASURY RESEARCH ACADEMY Blog:

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2 USDINR USDINR Spot: Spot: Rupee in Correction Mode or a Trend Reversal? The Rupee seems to be taking a breather ahead of key events lined up in November. Recent softening of crude prices (on assurance by Saudi Arabia to fill in the void left by Iranian crude after US sanctions kick in on 4th November) has been a big respite for the Rupee. Domestic bond yields have also cooled off on weaker crude prices. The implied probability from the OIS curve of a rate hike by the RBI in December has dropped to 50%. The Rupee has decoupled from the broader US Dollar and we could see this theme play out over the next few sessions. Rupee has remained relatively insulated to the weakness in domestic stocks too. Other market based indicators such as the 1M offshore-onshore spread and the 1M-3M ATM (at the money) vol spread also point to a temporary period of calm in the Rupee. During periods of panic, the offshore forward points are much higher than onshore forward points and the vol curve generally inverts such that the near term vols are higher than farther term vols. (White line represents the 1M offshore-onshore spread and Yellow line the USD/INR pair. The offshore points have cooled off, aiding the retracement in USD/INR) The Rupee may however not be out of the woods just as yet. How the oil market reacts when the US sanctions on Iran actually come into effect on 4th November remains to be seen. The crude prices could rally again if the supply is constricted. The broader US Dollar may continue to strengthen as long as the market continues to revise its expectations of the terminal federal

3 funds rate higher and the Rupee cannot remain decoupled for too long. However, housing data from the US needs to be monitored closely as recent existing and new home sales prints are pointing towards weakness emerging in the US housing market. This could cap the market s expectations of the terminal federal funds rate. The outcome of the US mid term elections on 6th November will set the tone for the US Dollar. The Republicans are expected to retain control of the Senate but concede the House to the Democrats. A stronger than expected show by the Republicans would be a positive for the US Dollar and negative for EM assets. (White line is the yield on 10y benchmark and Yellow line is WTI Matches crest for crest, trough for trough) Risks from Europe pertaining to the stability of the Merkel government in Germany, Italy s confrontation with the EU regarding Italy s populist budget and from UK pertaining to the progress of the Brexit negotiations with the EU also have the potential to send shockwaves through the global markets. After a setback for the CSU (CDU s sister party) in the recent Bavarian state elections, CDU s performance in the Hessian state election will be closely tracked. The EU has rejected Italy s budget and this is unprecedented for any EU member state. On Brexit, though the UK and EU have reached an agreement on several issues, the most contentious issue is that of the Irish border and until a mutually agreeable solution is found for the same the risk of a no deal Brexit and that of a leadership challenge for Theresa May cannot be ruled out. If no deal is reached between the US and China on trade by December, the tariffs would be increased to 20% from 10%. Any escalation in trade tensions between US and China poses serious risks to global growth and would be extremely negative for the overall risk sentiment. On the domestic front, the performance of the BJP in the upcoming state elections in Madhya Pradesh, Rajasthan and Chhattisgarh will be closely watched. While the BJP is likely to win in Chhattisgarh, it is likely to face defeat in Rajasthan. Madhya Pradesh is likely to be a close contest and therefore the most interesting. A stronger than expected show by the BJP would be positive for domestic stocks, bonds and the Rupee. The results of the elections are due on 11th December. The possibility of the current pain in NBFC space snowballing into a wider systemic risk is a major concern on the domestic front. Banks are unwilling to lend to NBFCs and mutual funds that were primary buyers of NBFC papers are seeing outflows from their

4 funds. Under these circumstances, the NBFCs, especially Housing Finance Companies are likely to find it extremely difficult and expensive to refinance their debt. Ensuring that adequate liquidity is made available to the NBFCs so as to avoid a freeze in credit off take and stall in growth would be a major challenge. The market would wait for triggers from the events mentioned above and therefore we may see the Rupee consolidate over the next few trading sessions in the range before we see the next decisive move. However, the broad trend of the USDINR pair is still up. From a hedging standpoint, Exporters can book short-term exposures through forwards or can cover through Put options between a spot of and for long term. Importers are advised to cover through call options or can hold with a stop loss of levels. ATM vol Curve (White line is as on 25th Oct and Grey line is as on 1st Oct. The vol curve, which was earlier inverted, has now normalized)

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