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The RBI chose not to surprise anybody and held status quo in terms of policy rates and money supply in the Policy Review on Tuesday. The more optimistic bulls who were hoping for a cut will now exit their long futures positions in the Bank Nifty, big banks and NBFCs. However, since most of the smart money wasn't expecting a cut at all, this inaction shouldn't trigger off a mass exodus.
We may see a correction in the Bank Nifty and a somewhat smaller one in the Nifty. The Bank Nifty is high-beta with respect to the broader market. The financial index has gone straight up from around 15,300 levels in mid-October to above 18,675 early this week. That's a move of 22 per cent in the space of about 6-7 weeks. In the corresponding period, the Nifty moved from around 7,900 to a recent high of 8,623. That is a move of nine per cent. A correction of five per cent or 10 per cent in the Bank Nifty would not be unusual in the circumstances. It may not happen, but the trader should be braced for it. If there is a correction of this order in the Bank Nifty, given the beta-correlation relationship, the Nifty could drop by about 2-4 per cent. Numerically, a Bank Nifty correction of somewhere between 1,100-1,800 points is not unlikely and this could trigger off a correction of about 250-350 points on the Nifty.
A trader could be looking to set up short positions with stop losses set in the region of recent record highs. For example, a short Bank Nifty futures with a stop loss at around 18,800 (which would be equivalent to a spot index level of 18,700) and a short Nifty futures with stop loss at about 8,700 would both look reasonable. In the longer term, the RBI policy statement makes it seems as though a rate cut early into 2015 is a distinct possibility. But it is more likely that the RBI will not do anything until the Budget is announced, along with the Economic Survey and 2014-15 full-year projections. There are likely to be base effects in the inflation indices through December and January but those would be known and adjusted for, before the Budget was announced.
The first full-year Budget for the NDA is likely to send several important signals. The government will have been in charge long enough to be held responsible for prevailing economic conditions. The Fiscal Deficit targets for 2014-15 will either have been met, or not, and that in itself, will give the central bank a clearer understanding of the NDA's capabilities. On the external front, the US Federal Reserve's intentions may also be clearer by end-February 2015. "Everybody", meaning the consensus, expects fairly large cuts by the RBI early into next year. The Treasury auctions have shown falling yields and yield inversions, which means that financial institutions are certainly braced for a cut of more than symbolic dimensions. The consensus is on 50 basis points with some enthusiasts saying even more is possible. More importantly, once the RBI starts cutting, it is likely to continue doing so over an extended period and the turnaround in the interest rate cycle should be positive for multiple industries. There is a sweet spot in an economic cycle when inflation is low, growth is accelerating and interest rates are falling. That could be hit next year once the RBI feels comfortable enough to cut policy rates.
The author is a technical and equity analyst
