Stage seems to be setting up for further rally in INR; equity; bonds and emerging market assets.
1. Dovish US Fed and ECB: US Fed has turned dovish and market has reduced probability of rate hike in today’s meeting. Even if rate hike happens, market does not expect more then 1/2 hikes. European Central Banks are echoing the view.
It means that investors would look for markets with growth and bond yields. India and Indonesia are clearly favoured in Asia (with with high growth and his bond yields)
2. Cooling inflation: Thanks to low food inflation and falling crude prices, we expect inflation to remain soft and may be even below 3%. This would mean RBI may even consider cutting interest rate ( we expect two cuts in 12 months). This move would aid USD inflow in Indian bonds and equity markets
3. Soft Crude and possible shape reduction in trade deficit. Brent Crude is drifting towards 50 levels (55 is imp support). If crude stabilizes around 50-60 levels, we expect March end trade deficit number to be below USD 10 bn and this would be a huge boost to INR.
4. Liquidity support from RBI: In a surprise move by RBI it announced a huge OMO of Rs 50 K crore to be auctioned in Jan-19. This means that now RBI would provide liquidity by buying bonds and not by buying USD. This also means that yields on bonds would further drop (may be 6.9-7% by March end) and as a result bank’s MCLR would also reduce. All in all good for equity and bonds.
.
5. Historical evidence of rally before elections: Historically, equity markets have rallied before general elections and we are seeing signs of same in last few days. Many mid and small cap stocks have started to gain day after day. Remember, similar situation in last election and equities rallied in Jan-April-2014 on back of softening inflation; rate cut by RBI.
Atleast for next few months it appears that markets would forget structural issues like worsening fiscal deficient (read farm loan waivers); slowing exports and ride the wave of soft interest rates and increased liquidity.
Considering above factors, we expect INR to trade with soft bias and may be see 66-67 by March end.