CURRENCY YEARLY OUTLOOK

2017

Overview When it comes to the financial markets, every year is historic in some way or the other, but 2016 will be remembered as an exceptional one. It will remain memorable for investors as it has thrown a number of surprises. It turned out to be a tumultuous one as Brexit and the US presidential elections had a major impact on the global financial space. The Brexit fiasco is considered to be the previous year’s major Black Swan event. Alongside, Trump’s win in the US Presidential elections made it a year of surprises.

The Brexit fiasco is considered to be the previous year’s major Black Swan event. Alongside, Trump’s win in the US Presidential elections made it a year of surprises.

Donald Trump’s win was a stunning culmination of an explosive, populist and polarizing campaign. The surprise outcome sent tremors throughout the world. The election changed the world for bond investors as there was a ripping selloff in global bond markets, which drove the US interest rates to the highest levels in a year. The selloff came on the expectation that Trump's promised infrastructure spending and tax cuts will result in higher growth, inflation and also higher amounts of the US government debt. The US dollar staged a stupendous performance against major currencies and went on a one-way street mainly because of the uncertainties that were a part of their market. The dollar tested its highest level against a basket of major currencies for almost 14 years, after a boost from Donald Trump's shock win as US President elect. The US currency rallied around 8 per cent versus the yen since the start of November, its strongest month since December 2009, and more than 3per cent against the euro, its best month in a year. As we have stepped into the New Year, a lot of changes will take place on the financial landscape where various European countries will face dilemmas over elections, while the final Brexit may take two years. In terms of Brexit, Parliament will also vote on the final Brexit agreement, the 'divorce settlement', between the UK and the EU. The rest of the world would also be bracing for potential headwinds, once the United States’ policies by the new President-elect come into play.

US FED policy rates

The US dollar staged a stupendous performance against major currencies and went on a one-way street.

Source : Reuters

The US FED and its impact on currency markets For almost an entire year, the Federal Reserve kept struggling to take a concrete stance about a rate hike. Markets always looked forward to the Fed meetings with caution, only to find statements from the US Federal Reserve about economic outlooks, job outlook etc. rather than rate hikes. But finally the For detailed disclaimer please visit http://www.religareonline.com/disclaimer

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meeting, signifying the Fed's confidence in the improving US economy. After the hike the US dollar rose to a 14-year peak against a basket of major currencies as the Federal Reserve boosted the number of projected interest rate hikes to three in 2017, up from around two flagged at its September policy meeting. This second rate hike in a decade was another key factor after Trump's win which led the rupee in the vicinity of all - time lows in December, 2016.

Emerging market currencies

The surge in the US dollar was more prominent after the US presidential elections and US bond yields also rallied amid concerns that government borrowing to fund possible stimulus could stoke inflation.

A rising US dollar has generally proved to be negative for emerging market currencies and in the last three months of 2016, Indian rupee has felt the effects of rising US dollar. The dollar index above 100 levels often spells bad news for emerging market currencies including India. The rally in the US dollar has weighed on most emerging market currencies including the rupee, Indonesian rupiah, Thai baht, Philippines peso and Malaysian Ringgit. The Chinese yuan also came under pressure and was down over 3 per cent in last three months of the year and around 7 per cent on an annual basis. The surge in the US dollar was more prominent after the US presidential elections and US bond yields also rallied amid concerns that government borrowing to fund possible stimulus could stoke inflation. For emerging markets, the rise in US yields has resulted in the unwinding of the dollar carry trade. The unwinding of dollar carry trade means a reversal of foreign capital from emerging market debt to high yielding US debt.

Emerging market currency performance

For emerging markets, the rise in US yields has resulted in the unwinding of the dollar carry trade.

Source : Reuters

As far as the emerging market space is concerned, India is better placed in comparison with other emerging market economies. Strong FII inflows, economic reform process like GST and strong domestic growth will guard the rupee from external shocks in the long term. The developing markets’ currencies including the Russian rouble, South African rand, Turkish lira, Chinese yuan and Brazilian real may outperform developed-market peers like the euro and yen, as interest rates rise in the US The performance of many developing market currencies especially the rouble and real to a large extent are linked to commodity prices. Since a significant portion of both Russia and Brazil’s economic output comes from oil exports. For detailed disclaimer please visit http://www.religareonline.com/disclaimer

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Among the major EM currencies leading the decline was the Mexican peso as Mexico sends nearly two thirds of its exports to the US and counts its northern neighbour as its biggest trading partner. The selloff in the peso was widely expected following a Trump win, given Trump’s fiery rhetoric on trade, immigration and wall building. Brazil is much less dependent on the US for trade and would therefore be less exposed to any shift towards more protectionist policies.

FII flows

In 2016, the net inflows turned negative making it the worst year for the Indian capital markets in terms of foreign investment since 2008.

The start of 2016 saw foreign institutional investors pulling out from India and other emerging markets. Foreign investors pulled out around Rs.22,529 crores both in equity and debt in January and February. They pumped in money thereafter but FIIs turned net sellers again in October. For the full year, they are net buyers of Rs.20,566 crores in equity but they are net sellers in debt market to the tune of 43,645 crore resulting in net selling (combining equity and debt) to the tune of Rs.23,079 crores. It is the debt instruments that have seen the biggest outflows, after remaining a favourite investment destination for foreign funds in the past, even as equities continued to attract net inflows, they were not enough to offset the huge outflows from the bond market. In 2016, the net inflows turned negative making it the worst year for Indian capital markets in terms of foreign investment since 2008. In 2008 FIIs sold heavily in Indian markets owing to a global financial crisis.

FII Investment in Equity & Debt Equity

Debt

The first half of 2017 is likely to remain subdued in terms of foreign capital flows given the rising US yields and uncertainties on the domestic front that will take some time to settle down.

Rs. (in thousands cr.)

200 150 100 50

159

133

128

46

0

42

113

97

34

17

45

20

-2

-50 2010

2011

2012

-50 2013

2014

2015

-43 2016 Source : NSDL

The inflationary environment on the back of rising bond yields in the US has led to the outflows. The massive dollar strength, expectations of rate hike by the US Federal Reserve and the Trump winning the US presidential elections have been the major factors for Foreigners pulling out money from India. The selling in debt increased due to the market expectation of three US rate hikes in 2017. The demonetization drive created a domestic cash crunch and sparked selling pressure in the capital markets. This drive may result in slower production and domestic consumption at least for a quarter. The first half of 2017 is likely to remain subdued in terms of foreign capital flow given the rising US yields and uncertainties on the domestic front that will take some time to settle down. Going forward, it will all depend on the growth in different markets. With US markets expected to grow at a faster pace while Indian and other emerging economies may see a slowdown, the year 2017 may be a subdued year especially in terms of inflows from foreign investors.

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The Indian Rupee The start of 2016 proved to be painful for rupee as it saw the local unit flirting with its all-time lows and igniting concerns of a 2013 like historic depreciation. However, rupee made a staggering comeback all the way to 66.30. The major factors contributing to the recovery were the strong domestic economic climate, passage of GST bill, inflation within the comfort zone and lower import bill due to subdued crude oil prices. But starting November, the tables turned and rupee again went in doldrums mainly due to the FCNR redemption, demonetization and the Trump’s win in US presidential elections that pushed the dollar index to a 14 year high. Rupee sank to a record low against the dollar; global funds were on a selling spree as they were seen exiting from Indian and other emerging markets on the back of mounting expectations of a US rate hike.

Rupee was weighed down by $26 billion worth of FCNR redemption in the month of November. This redemption of FCNR deposits was broadly expected to keep the rupee weak during the month of November, 2016.

Rupee was also weighed down by $26 billion worth of FCNR redemption in the month of November. This redemption of FCNR deposits was broadly expected to keep the rupee weak during the months of November and December 2016. However, the RBI was well prepared to deal with the impact of redemptions to a large extent, thanks to the strong foreign exchange reserves that the RBI has built over the past couple of years. A lot of new developments took place on the domestic front, like the surprise announcement of RBI governor Raghuram Rajan not to seek re-appointment when his term ends. A Monetary Policy Committee (MPC), a 6-member panel was set up, to raise transparency in rate setting decisions of the central bank. The committee will have 3 members from the RBI (including the governor) and three members will be selected by the Government. In another historic event, a unanimous decision was taken in August 2016 when Rajya Sabha approved the crucial constitutional amendment to turn the Goods and Services Tax Bill into a law. After the passage, the Centre set up a GST Council. In November, the GST Council finally agreed on a multi-layered rate structure as 0 per cent, 5 per cent, 12 per cent, 18 per cent and 28 per cent, different from popular international practice of having one rate of tax for all goods and services. The government also took a decision that the Union Budget will be presented on the first working day of February. The Government will not present a separate railway budget but will include it in the main budget. Then came the historic decision of demonetisation of Rs.500 and Rs.1,000 notes in an attempt to crack down on black money.

Impact of demonetization Demonetization of high value notes resulted in a cash crunch and has sparked concerns about a fall in GDP. The drive may result in lower production and consumption at least for a quarter. The World Bank has cut India's GDP growth for 2016-17 fiscal to 7% from its previous estimate of 7.6%, citing the impact of demonetization. In India, cash accounts for more than 80 per cent of the number of transactions and the World Bank has observed that in the short-term, 'demonetization' could disrupt business and household economic activities, weighing on growth.

GDP The Reserve Bank of India trimmed the GDP growth forecast for the current fiscal sharply to 7.1% from 7.6% target earlier. Various rating agencies have lowered the GDP forecast for 2016-17 due to concerns about the impact of demonetization. The downward revision is fallout of the interruptions that may be caused at various levels in the economy due to demonetization. India's fiscal deficit in the first eight months of the current financial year that started Apr. 1 totalled 4.58 trillion rupees, narrowing from 4.84 trillion rupees in the comparable year earlier period. Fiscal deficit for the April-November For detailed disclaimer please visit http://www.religareonline.com/disclaimer

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period was 85.8% of the government's estimate for this financial year. The deficit was 87% of the budget aim in the same period last year. While government revenue totalled 7.96 trillion rupees, total expenditure stood at 12.87 trillion rupees during April-November period. Net tax income totalled 6.21 trillion rupees. A sharp jump in the November factory output numbers is a pleasant positive surprise for the economy amid slowdown stories in the aftermath of demonetization. The index of Industrial Production (IIP) rose to a 13-month high of 5.7 percent in November, compared with a contraction of 1.8 percent in the month of October.

The inflation has cooled off as the Consumer Price Index (CPI)-based inflation fell to 3.41% in December, a record low in the new series from 3.63% in November. In December last year, the number was quite high at 5.61%.

Inflation Monthly CPI

Source : Reuters

The Wholesale Price Index (WPI)-based inflation for December, 2016 came in at 3.39 per cent against 3.15 per cent in the previous month.

The inflation has cooled off as the Consumer Price Index (CPI)-based inflation fell to 3.41% in December, a record low in the new series from 3.63% in November. In December last year, the number was quite high at 5.61%. The Wholesale Price Index (WPI)-based inflation for December, 2016 came in at of 3.39 per cent against 3.15 per cent in the previous month.

Current account deficit India posted a current account deficit of $3.4 billion, or 0.6% of gross domestic product (GDP), in the July-September quarter. The CAD in the second quarter was higher than the first quarter (April-June) CAD of 0.1% of GDP, but lower than the same quarter (July-September) a year ago at 1.7% of GDP. The contraction on a year-on-year basis was on account of a lower trade deficit ($25.6 billion) brought about by a larger decline in merchandise imports relative to exports. On a cumulative basis, CAD narrowed to 0.3% of GDP in the first half (April-September) of 2016-17, from 1.5% during the same period a year ago as trade deficit narrowed to $49.5 billion from $71.3 billion during the comparable period.

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Dollar Index Monthly Chart

Source : Reuters

On the technical front, a dawn of new bull cycle began for the dollar Index in 2016.

We expect the US dollar to continue its upward trajectory and test 109 levels by year end.

Technical outlook : Dollar Index

Dollar Index all geared to test 109 levels As 2016 was about to end, the most dominating headline in the forex space was the vertical rise of the US dollar. The sea change in the prospects of the US dollar tells us how dramatically the perception of investors has changed with regards to the performance of the US economy. With the US data generally improving and other central banks growing more dovish, all favoured a further rise in the dollar. On the technical front, a dawn of new bull cycle began for the dollar Index. The index is bang at its 14 year highs, holding well above its 50-week moving average. From a long-term point of view, the dollar index has given a breakout from its lengthy consolidation above 100.50 mark. It was a yearlong consolidation that has added more weight to the bullish implications of the breakout. The index has been able to hold on to these gains. The strong thrust is certainly indicative of further upside and the next formidable resistance is around 109 mark. However, after the recent upwards rally, some corrections are likely where the level of 97 will act as a good support area for the greenback. We expect the US dollar to continue its upward trajectory and test 109 levels by year end.

USDINR Weekly Chart

Source : Reuters

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Technical outlook : USDINR

USDINR looks set for a rally towards 72

The technical structure for USDINR pair looks positive and after some consolidation the pair may move past the resistance of 69 and witness a rally towards 72 in 2017.

Every age of trading history has experienced different types of market movements that have been instrumental in the development of long term trends. Bulls and bears in USDINR have seen a continuous battle and have been successful in toppling thrones of the lesser strong opponent and have redrawn borders of supports and resistances. The tussle between bulls and bears kept the pair in a sideways zone for a fairly long period of time spreading from June till October, 2016. Then appeared the successful siege of bears and the pair saw a rally which spread the notorious dogma that a historic rally similar to that of 2013 might be in the offing. Looking at the long term charts, the level of 66 appears to be a sacred level for the bulls, which has not been broken since December 2015. After the rally that began in November, the pair took a small correction but is again trending higher. While the USDINR came in the vicinity of its record highs, but has still not breached the crucial 69 mark which is restricting further wave of upwards momentum in the pair. The technical structure for USDINR looks positive and after some consolidation, the pair is likely to move past the resistance of 69 and may witness a rally towards 72 in 2017.

Euro Euro had its ups and downs, where the beginning of the year witnessed a rally towards highs of 1.534 in May, before tumbling to 1.100 after Brexit and then towards lows of 1.036. The key driving factors early in the year were the weaker US dollar, and the Fed’s reluctance to raise interest rates.

The dollar is on a roaring run, and the euro is in trouble. It seems the story of 2000 may happen all over again and the euro bears look set to win the battle.

In March, the ECB unleashed a larger than expected package of measures aimed at stimulating the Euro Zone economy, with expanded quantitative easing, incentives to the banks to increase lending and further interest rate cuts. Since the mid of May, Euro started its decline and continued to weaken as German 10-year Bunds slipped below zero per cent. The historic British referendum in June’16 further sent the single currency in the doldrums. After the Brexit sell off, there were stretches of low volatility in EURUSD pair during third quarter of calendar year 2016, that eventually gave way to significant price movements in the last quarter of the year, largely catalysed by central banks’ actions and political developments. Volatility returned with the election of Donald Trump as President of the United States. That gave a boost to the US dollar and dragged Euro lower. The single currency continued its decline in December after the ECB decided to trim its monthly bond buying program beginning in April 2017, cutting its monthly bond purchases to 60 billion euros from 80 billion. This decision came as a shock to the markets, which expected the ECB to carry on with its "quantitative easing" at its current pace for some months. However, the shock was somewhat allayed by the ECB’s announcement that it would extend its purchases for nine months till the end of 2017. The ECB also left its key deposit rate unchanged at -0.4%, with its refinancing rate and marginal lending rates staying at 0% and 0.25%, respectively. The US Federal Reserve increased its key interest rates in Dec 2016, that further pushed EURUSD lower. The US dollar seemed all geared up to bludgeon the euro back below parity. Sixteen years back euro witnessed its first dive below parity, when European currency was growth starved and the greenback was on a roll. History repeats itself and in the case of the euro-dollar it looks like groundhog day for the euro returning back below parity fairly soon. The dollar is on a roaring run, the dice

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is loaded and the euro is in trouble. It seems the story of 2000 may happen all over again and the euro bears seem to win the battle.

EURUSD Weekly Chart

The long term charts suggest that euro is in a bearish trend and likely to continue its decline further. It may be at parity with the US dollar.

Source : Reuters

Technical outlook : EURUSD

Euro to be at parity with the US dollar

The EURINR pair has taken support around the 70 mark but given the weak chart structure, the pair should head lower towards 68.50 levels in 2017. The rallies may be used as opportunities to sell.

EURUSD initially rallied to around 1.16 levels in the mid of May, but could not sustain at higher levels as it was near its resistance zone seen in 2015. Correction ensued in the pair and eventually it entered a sideways consolidation that ranged for a few months. However, the consolidation finally gave way to a selloff, leading the pair to breach below its long term support of 1.050. The pair seems to have fallen too far, too fast especially after the US election's peak of 1.1298 to lows of 1.0350. The pair ranged within 1.0500 and 1.1600 levels for almost two years, while the sharp decline post Brexit has brought technical indicators on daily and weekly time frame in an oversold territory. This may lead to some consolidation or a small pull back in the pair. However, the long term charts suggest that the single currency is in a bearish trend and is likely to continue its decline further and be at parity with the US dollar.

EURINR Weekly Chart

Source : Reuters

Source : Reuters

EURINR tested a high of 77.68 in the early part of the year and then continued its decline. The pair then entered a sideways consolidation from where another For detailed disclaimer please visit http://www.religareonline.com/disclaimer

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bout of selling dragged the pair lower. On the upside, the pair has resistance at 74.50 levels followed by 78 mark. The pair has taken support around the 70 mark, but given the weak chart structure, the pair should head lower towards 68.50 levels in 2017. The rallies in the pair should be used as opportunities to sell.

Pound

2016 will go down the history lane as the year which saw the UK vote to leave the EU.

The outlook of pound will majorly be influenced by the subject of Brexit, and the impact of the referendum is likely to be felt for considerable time to come.

2016 will go down the history lane as the year which saw the UK vote to leave the EU. This unexpected development stimulated significant turbulence for the pound exchange rate. There was a vicious fall in GBPUSD pair and it fell to 31 year lows. As the year progressed, pound gained some lost ground and recovered somewhat from its post-referendum weakness before the close of the year, but it nevertheless remained fragile and highly vulnerable to further decline in the coming months. The EU referendum was a game changer for Sterling that almost removed the currency’s correlation to domestic data and also created strong political headwinds. The outlook of pound will majorly be influencedtt by the subject of Brexit, and the impact of the referendum is likely to be felt for considerable time to come. Prime Minister Theresa May has said Parliament will vote on the final deal that is agreed between the United Kingdom and the European Union that will weaken the negotiating leverage of UK, as the terms of the deal would be decided by other 27 countries. Britain will leave the EU's single market when it exits the European Union, putting an end to speculation about a "soft Brexit". Even if Parliament votes down the deal it would not stop Brexit. Britain would still leave within two years, unless all 27 EU member states agree to extend the deadline. As the negotiations unfold, the pound will react to any indications as to the likely shape of the UK’s future relationship with the EU. If parties from either side of the Channel take a harder line of rhetoric then the sentiment could turn increasingly bearish. On the flipside, if talks appear to be more agreeable then the GBP exchange rate could get some more sustained support. However, it seems unlikely that the UK government will be able to strike a deal that it wants without compromise.

GBPUSD Monthly Chart

Source : Reuters

Technical outlook : GBPUSD

Source : Reuters

After the initial plunge from 1.5016 to 1.279 levels post Brexit, the pair consolidated for two months within a range of 1.3450 and 1.2870, but bears again pressed the sell trigger and a further sell off all the way down to 1.2000 levels was seen. For detailed disclaimer please visit http://www.religareonline.com/disclaimer

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Sterling is likely to witness downside pressure though some corrective counter rallies up to 1.30 levels may be seen but they should be used to create short positions. On the downside, the pair looks set to test 1.18.

While navigating through the monthly charts and deciphering the long term trend, the pair has breached the crucial support of 1.400 and since then the pair has been under continuous pressure. The pair is likely to witness downside pressure though some corrective counter rallies up to 1.30 levels may be seen but they should be used to create short positions. On the downside, we expect the pair to test 1.18 and a break below that should take it to 1.13 levels.

GBPINR Weekly Chart Technical outlook : GBPINR

Source : Reuters

Source : Reuters

GBPINR is expected to remain under pressure and lower levels of 79 can be seen.

On the monthly time frame, the GBPINR pair has broken down from a double top pattern with a neckline at 91. The pair has support around 79.65 levels that is the recent low it tested in October followed by 76.65 mark. The technical structure looks weak, though the pair may see some corrective rallies that may take it to 88 levels, but those can be used to seek short selling opportunities. We expect the pair to remain under pressure and lower levels of 79 can be seen in GBPINR.

Yen The start of 2016 saw yen rallying around 16 per cent against the US dollar and traded at levels last seen in 2014. The primary reason for the yen rallying sharply in the early part of the year was the US Fed refraining from another rate hike. Ever since the Federal Reserve raised interest rates in December 2015, expectations for the pace of hikes in 2016 slowed dramatically. This Fed’s tilt towards a much more cautious outlook raised investors’ concerns about slowdown in global growth. This became the primary culprit for the dollar’s weakness against the yen. The other factor contributing to the yen rally in first half of 2016 was the ineffective BOJ monetary policy. Prime Minister Shinzo Abe was voted into office in late 2012 based on the promise that his administration would do everything it could to revive economic growth and inflation in Japan after nearly two decades of stagnation. To this end, the central bank set a price stability target of 2% growth, as measured by the year over year change in the consumer-price index. The central bank seems to have fallen miserably short of this goal despite undertaking extraordinary stimulus measures. However, in the later part of the year the Bank of Japan affirmed its current monetary policy stance with short term policy rates at -0.1% and a target yield on Japanese government bonds around zero. With the BoJ holding steady and the Fed embarking on a rate hiking campaign, the yen started to weaken and USDJPY headed higher towards 118.60 levels.

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In the past many central banks have been successful in using monetary policies to maintain forex rates. The ECB designed its monetary policy to maintain desired levels in EURUSD, pushing the pair down from 1.400 to 1.050. Similarly in the USDJPY pair, the US Fed’s recent decision to raise interest rates was followed by BoJ’s decision to maintain rates. This weakened the yen against the greenback. This interest rate differential has been the main driver in the softer yen: US funds become more expensive as the Fed tightens, while Japan funds continue to be very cheap on the continued negative interest rates, leading to a yen sell-off. The exchange rate has sharply gone up from around 100.40 in late September to 118.65 in the middle of December, this is the steepest three month change seen in two decades.

As the Fed has announced three potential rate hikes in 2017, this makes it very unlikely for the US yields to fall. A rising interest rate trajectory will keep the capital flowing into the US from other economies, leading the USDJPY pair to surpass the psychological 120 mark.

The BoJ’s decision shows its commitment to control the yield-curve, retain the purchase of bonds at the current rate of 80 trillion yen a year, and target inflation increase to 2% from the current level of -0.4%. As the Fed has announced three potential rate hikes in 2017, this makes it very unlikely for the US yields to fall. We believe that a rising interest rate trajectory will keep the capital flowing into the US from other economies, which may lead the USDJPY pair to surpass the psychological 120 mark. However, an excessively weaker yen may prompt the BoJ to intervene again to maintain rates beyond a certain level. Therefore there is a high chance of BoJ intervening, if USDJPY remains above 120 mark.

Technical outlook : USDJPY USDJPY started 2016 on a weak note and gave a bearish break down from a Head & Shoulders pattern on the weekly and monthly time frames with a neckline around 116 levels. The pair was in a severe down trend post the breach of 116 levels and saw many short term consolidations that were broken on the downside. It plunged significantly to finally find support around 100 mark and reversed its downtrend to head higher. The sharp rally that ensued took the pair towards 118.50 levels. The current up move may face resistance at 120 levels, from where a correction is expected. However, after a correction we expect the pair to head higher towards 127 levels.

JPYINR Weekly Chart

Technical outlook : JPYINR

Source : Reuters

Mirroring the USDJPY movement, the JPYINR pair rallied in the first half of the year with strong momentum and tested levels of 68.00. As the international pair reversed so did the fortunes of JPYINR, where the pair started to decline sharply after it breached below the key support of 63.50. The pair moved in to the strong grip of bears and fell to the wallows and tested 57.50 levels. As the pair is now heavily oversold, a relief rally can be seen towards 61.00 levels. Then the resumption of downfall should begin and the pair may head lower towards 56.50 levels. For detailed disclaimer please visit http://www.religareonline.com/disclaimer

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Bond market For around three decades, interest rates have been falling resulting in strong uptrend in bond prices. This trend was accelerated after the Global Financial Crisis, when central banks began flooding the world with cheap money known as Quantitative Easing. The governments of the US, UK, European Union and Japan, issued large amounts of bonds. Investors accumulated vast war-chests of government bonds, that drove prices higher and yields or interest rates lower. Donald Trump's win and his promise of tax cuts and plans for massive infrastructure spending has changed perceptions. This has raised concerns that inflation may grab hold as the US economy strengthens, prompting investors to dump government bonds. Trump’s plans are expected to do what the US Fed was unable to do, trigger the return of inflation. It's not only US where bond selling was seen, heavy selling was also seen across Europe.

The bond yields are likely to head higher in 2017, but the rise in yields will vary across countries. Yields in Germany are likely to move away from their negative territory. The European and US 10-year yields are likely to move upwards in H1 2017.

We expect bond yields to head higher in 2017, but the rise in yields will vary across countries. Yields in Germany are likely to move away from their negative territory. The European and US 10-year yields are likely to move upwards in H1 2017. Italy is a concern going forward as the banks in the country are sitting on huge bad debts that may trigger some financial crisis. Diverging monetary policies are likely to impact bonds in the year ahead. The later part of 2016 was good for US and European stocks due to Trump’s effect. Going ahead, the year 2017 will be more challenging as investors will look for real action on Trump’s policies to boost growth.

Global 10 year bond yields

Source : Reuters

The Indian bond market witnessed stupendous rally in 2016. India’s benchmark sovereign bonds posted their best performance since the global financial crisis. Bond market was also helped by RBI's decision to cut rates as inflation cooled off. There have been record debt purchases by banks and they are the biggest holders of government securities. RBI kept purchasing bonds as part of its commitment to improve money supply in the banking system and government’s currency recall flooded the system with cash which caused the yields to drop further. The 10-year benchmark bond yield fell to 6.80 per cent and reached levels seen back in 2009.

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Weekly GOI 10 year bond yield

We expect an initial dip in GOI 10 year yields up to 5.80 and thereafter we expect the yields to move up to around 6.90. A range bound year for bonds in 2017 is likely.

Source : Reuters

Indian yields have plunged whereas the yields in the US have surged sharply as the Fed raised interest rates in December and signalled three rate hikes in 2017. That has reduced the gap between Indian and US Treasury rates, weakening the appeal of Indian debt for overseas investors. Following this narrowing of gap, the foreign holdings of Indian government and corporate bonds have seen a decline. 2016 was a good year for Indian bond markets in terms of capital appreciation. There is a possibility of a dip in GDP due to demonetization and that may create pressure on RBI to cut rates. So the chances of rate cuts are higher in 2017 and that should be positive for bonds. But at the same time the markets are already discounting a 50 basis point rate cut at current yields of 6.50 per cent. Given the fact that a lot of money will flow into the US on back of narrowing of interest rate differential between the US and other emerging markets, we don’t expect the bond market to perform the way they have in 2016. We expect an initial dip in GOI 10 year yields up to 5.80 and thereafter we expect the yields to move up to around 6.90. So broadly, a range bound year for bonds in 2017 is likely.

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Forex Forecast: 2017 Currency Pair Closing Price

H1 2017

H2 2017

USDINR

67.92

68.70

72.00

Dollar Index

102.33

97.50

109.00

EURINR

71.47

74.50

68.50

EURUSD

1.0524

1.09

1.00

GBPINR

84.05

88.00

79.00

GBPUSD

1.2322

1.30

1.18

JPYINR

58.12

61.50

56.50

USDJPY

116.86

113.50

127.00

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Sources: www.reuters.com | www.bloomberg.com | www.fxstreet.com | www.rbi.org | www.finmin.nic.in Analyst - Nirmal Tewari

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