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SGX Nifty Surged to a Four-Month High on Positive Global Cues as JPM Bails Out FRC

Published 02-05-2023, 06:39 pm
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SGX Nifty (India 50), the overseas derivative/CFD of India’s benchmark index Nifty made a three-month high around 18275 early European sessions Monday in a holiday-thinned trade on positive global/U.S. cues as JPM bought out troubled regional U.S. bank First Republic Bank (FRC). Wall Street was under pressure last week on FRC and Fed rate hike panic.

FRC's (First Republic Bank) Q1CY23 report card was subdued amid higher-than-expected deposit outflow. FRC tumbled after the Q1CY23 report shows a $100B deposit outflow in March. Also, deposits were down for various other U.S. regional banks. FRC is also considering asset sales worth up to $100B while losing an advisor team that managed $13B. Another large group of financial advisors has left the FRC as the troubled lender loses deposits and its stock price falls. FRC’s business has been under the microscope of authorities and the rest of the commercial banking sector after the failure of Silicon Valley Bank (SVB). First Republic Bank was still looking into strategic options with multiple parties (mergers).

Also, the overall risk trade sentiment was affected as Fed officials called for broad changes to bank regulatory rules in the aftermath of SVB’s (Silicon Valley Bank) failure. Fed blamed SVB's failure on management and inadequate regulatory supervision issues. The same logic holds for other U.S. regional bank failures like Silvergate and Signature Bank.

But Wall Street Futures also recovered Friday (U.S. session) after a report that First Republic Bank (FRC)is most likely headed for FDIC receivership. Troubled regional U.S. lender First Republic Bank is likely to be taken into receivership by the U.S. Federal Deposit Insurance Corporation (FDIC). Earlier last week, there was a report that the US government is not interested in intervening to help the bank from collapsing, and no private entity is interested in taking over the lender without ‘substantial Federal guarantees’.

On late Friday/weekend, there was a further report that JPM and PNC are interested in buying out FRC and FDIC has asked for final bids from them. SGX Nifty Future made a high around 18225 Friday U.S. sessions before closing around 18210 in line with Dow Future movement (against India Nifty Future closing levels around 18113). Finally, in the early European session, FDIC confirmed that JPM is buying out FRC. Subsequently SGX Nifty made a high around 18275.

But on Monday, Dow/SGX Nifty Future also slips from the FRC bailout high on subdued PMI data from China, and the FRC news was already discounted to some extent. Also, on Monday ISM/S&P Global Manufacturing PMI for the U.S. indicated a revival of inflationary pressure and employment, while manufacturing activities were better in April than in March, although still near the contraction zone. After better than expected ISM manufacturing PMI data, USD/US bond yield surged, while Wall Street Futures, Gold slumped as Fed may go for not only a +25 bps hike on 3rd May, but also 14th June. Subsequently, SGX Nifty Future also made an opening session low around 18192 Tuesday.

The market may be now concerned about consecutive bank failures in the last few weeks led by Silicon Valley Bank (SVB)-$209B; Silvergate Bank-$11B; Signature Bank-$118B; and First Republic Bank-$233B. The growing list of troubled U.S. regional/small banks as a result of rapid hikes in Fed rate/bond yields coupled with poor regulatory supervision may be an indication that consolidation in the U.S. banking space is inevitable.

Small players may not be suitable no-longer for banks as much higher regulatory/buffer capital is required in unexpected times of stress or even to counter huge MTM losses in the HTM bond portfolio. The market is now concerned about not only higher rates for longer but also a growing baking crisis, especially in U.S. small/regional banks as a result of higher bond yields; i.e. lower bond prices and MTM loss in bank HTM bond portfolios.

Wall Street is also suffering from an acute earnings recession even before the actual recession on Main Street; the market is also concerned about the lingering U.S. debt limit drama. The market is now concerned about the lingering U.S. debt limit saga (yearly ritual) as it’s getting serious; the US five-year credit default (CD) swaps rise to 171 bps, the highest since 2011.

In a way, Dalal Street surged almost +2.5% last week on a tech earnings boost in Wall Street (led by Meta/Facebook, Alphabet/Google, and Microsoft (NASDAQ:MSFT)). India’s techs also recovered led by Wipro (NS:WIPR) (buyback), TCS (NS:TCS), and Infy (value buying after a recent fall). Also, RIL and HDFC duo helped.

Nifty made a multi-day low around 17553.95 Friday (21st April) on the muted report card by tech major Infy and TCS, coupled with a market rumor/BBG report that the government is preparing an overhaul of its direct tax laws, including potential increases in capital gains taxes for top income earners, to help PM Modi reduce widening income inequality. But on Friday, the Finance Ministry sources said that there is no ‘discussion’ on capital gains tax, calling media reports 'baseless'. Subsequently, Nifty got some boost (technical short covering) and closed the week around 17624.05, still down -1.14%.

On Tuesday, India’s Dalal Street was also buoyed by record GST collection for April’23 (around Rs.1.97T), upbeat manufacturing PMI (4-month high), and cut of a windfall tax on crude oil export (positive for crude oil producers like ONGC (NS:ONGC), RIL, and Oil India (NS:OILI)).

On Tuesday, Nifty was boosted by INFY, RIL, ICICI Bank (NS:ICBK), L&T, Axis Bank (NS:AXBK), Maruti (NS:MRTI) (upbeat April sales figure), ONGC, Tata Steel (NS:TISC), NTPC (NS:NTPC), TECHM (NS:TEML), HDFC, and Hindalco (NS:HALC), while dragged by Kotak Bank (subdued report card), Bharti Airtel (NS:BRTI), HDFC Bank (NS:HDBK), Sun Pharma (NS:SUN), SBIN, Ultratech Cement (NS:ULTC), Bajaj Finance (NS:BJFN) and Hero Motors. On Tuesday, the Indian market was boosted by metals, energy, techs/IT, automobiles, infra, media, selected banks & financials, while dragged by pharma, FMCG, and realty.

The market was pricing around 75% of another +25 bps rate hike on 3rd May and no hike on 14th June after renewed concern about FRC last week. But now, after the FRC bailout by state-sponsored JPM buyout, the market is discounting 100% of another +25 bps rate hike on 3rd May and 40% of another rate hike on 14th June. Thus USD/US bond yield surged, while Wall Street/Dalal Street Futures and Gold stumbled. 

The average U.S. core inflation (PCE+CPI) is now around +5.20% and thus Fed may keep the terminal repo rate at least at 5.25-5.50% till Dec’23 (real positive/zero interest rate) to curtail demand (slowing economy) and bring inflation towards +2.0% core inflation target. Thus May hike of +25 bps is almost certain for Fed while there is a question mark for June. But there will be no rate cuts at least till mid-2024 contrary to market expectations. After mid-2024, Fed may begin talking about rate cuts (just ahead of the Nov’24 U.S. Presidential election) to boost Wall Street (risk trade) and also to ensure lower bond yields to rescue U.S. regional banks and itself. Fed has to also ensure lower borrowing costs for the U.S. government as well as businesses and households.

The U.S. core PCE inflation dropped from around +5.4% in Feb’22 to +4.6% in Mar’23; i.e. almost -1% in the last 12 months. At this run rate, it may fall to around +3.5% by Mar’24, +2.5% by Mar’25, and +2.0% targets by Dec’25. But average U.S. core CPI is now also running around +5.7%, almost +100 bps higher than Fed’s preferred core PCE inflation and this gap of +1% is running since Jan’22. The average core inflation (PCE+CPI) is now around +5.20% and thus Fed may keep the terminal repo rate at least at +5.25%, if not +5.50% till Dec’23 (real positive/zero interest rate) to curtail demand (slowing economy) and bring inflation towards +2.0% core inflation target. In a way, now Fed hike of +25 bps on 3rd May is almost certain, but there is a question mark for another Fed hike of +25 bps on 14th June.

In the last year, RBI hiked the +250 bps repo rate and core CPI declined -100 bps from around +7.0% to +6.0% on average; Indian 10Y bond yield also moved up around +100 bps from around +6.0% to 7.0%. At this run rate, if RBI goes for a pause around the 6.50-6.75% repo rate, the core CPI may further fall to around +5.0% by Mar’24 and +4.0% target by Mar’25.

If Fed continues to hike even after June’23 to +6.00% by Sep’23 (in case U.S. core inflation surges more), then RBI also has to hike (under still elevated/sticky core inflation). Thus RBI may like to keep the repo rate at 7.00% to 7.50% in CY23, depending upon the Fed rate action; as USD is the reserve/global currency, every major Central Bank has to follow Fed action to maintain bond yield/currency and policy differential (whatever may be the narrative) to control imported inflation.

Thus RBI again reminded the market on the 6th April MPC statement about the real rate of interest of +4.50% in Feb’2019 (when RBI starts the pre-COVID rate cut cycle to support economic growth); in Feb’2019, RBI repo rate was +6.50%, while headline CPI was around +2.00%, but core CPI was around +5.25%. Thus the actual real rate of interest about core CPI was around +2.25% in Feb’2019 against Rajan’ (former RBI Governor) preference of around +1.50% (1.00-2.00%).

On 17th April, RBI Governor said in an interview at a G20 event about RBI’s plan to pivot when inflation reaches the near target (+4%):

“During the COVID times, our inflation target was 4% with a tolerance band of 2% on either side, i.e., 2 to 6%, which is tolerable. During the COVID times, because we had to provide support to the economy, the Monetary Policy Committee of the Reserve Bank of India decided to tolerate slightly higher inflation. But then the time came when it exceeded 6%, which was the problem.

The moment, it exceeded that, by that time COVID was behind us. We acted in time, and in about six successive meetings, we increased our policy rate by about 250 basis points. Now the inflation, in the latest print, has come below 6.0%. The MPC, in the last meeting, decided that we have already done a 250 bps rate increase over the last year. Let us assess it, and the MPC decided to take a pause, but not a pivot. We have paused to assess the full play out of the impact of all the actions that we have taken over the last year and then take a call in the next MPC meeting for future action depending on the incoming data, and the outlook. We are now basically pausing, not pivoting.”

India’s RBI may also hike +0.25% on 8th June if Fed goes for two consecutive hikes on 3rd May and 14th June. Unlike RBI, Fed does not attempt to surprise the market and is sharing/providing appropriate forward guidance through not only official Fed communications but also regular Fed talks. Thus by 31st May (the Fed blackout period begins), the market as well as RBI should know with almost 100% certainty whether Fed will go for another +25 bps rate hike on 14th June.

If Fed refrains from any rate hike on 14th June and only goes for a +25 bps rate hike on 3rd May, then RBI may not go for any hike on 8th June and may continue to be on pause until core inflation does not spike abnormally. Going by the trend between RBI and Fed rate action since Jan’22, RBI may go for a +25 bps rate hike every alternate meeting if Fed goes for similar +25 bps rate hikes in every meeting (in a hypothetical scenario).

Under Governor Das and Modi admin, RBI may prefer to keep the real rate of interest around 0.50-1.50%; as India’s core CPI is now averaging around +6.00%, RBI may keep the terminal rate between 6.50%-7.50% in the coming days depending upon the actual Fed rate action and domestic core inflation trajectory. As there are a series of state elections in 2023 and also a general election by May’24, RBI may keep the terminal repo rate around 6.50-6.75% if Fed does not go beyond +5.50% and India’s core CPI stays below +6.50%.

Bottom line:

In the short term, on 3rd May, after another +25 bps hike to the +5.25% repo rate, Fed may indicate further debate/discussion about an appropriate restrictive terminal rate rather than an outright pause/pivot from June. Even in that scenario, Dow Future may further rally 700-1000 odd points from present levels of 34000 and then may correct. If Fed does not indicate any pause discussion for June, then Dow Future may fall again to 32000 levels.

Technical View: SGX Nifty Future (18225 CMP)

Looking ahead, whatever may be the narrative, technically SGX Nifty Future now has to sustain over 18325 for a further rally to 18425*/18550-18725*/18850 and 19050* in the coming days (Bullish side). On the flip side, sustaining below 18275, SGX Nifty Future may again fall to 18150/18100*-17925/17775 and 17550*/17300-17000/16800* and 16650* in the coming days (bear case scenario).

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