INR update: Volatility squeeze over? RBI policy coming up

The selloff in equities was perhaps caused by a volatility squeeze. As VIX fell to multi-year lows, the inverse vol funds made a lot of money and grew in size, little did we know that there growth can cause this kind of volatility without underlying fundamental reasons. The trigger for a volatility squeeze could have been the rising yields but that was not really the reason, as we know now. With some of the large inverse vol funds almost wiped out or shrinking in AUM to a level where they stop being consequential, the markets should soon return to normal or perhaps already have.

 

USD Index was unable to break the crucial resistance of 89.9 while US10 Y yields are up at 2.78% again. The US10y-2y spread is at 70 bps which shows that an increase in spread is not causing USD to appreciate by much. The safe haven appeal of the dollar therefore withers down if the volatility play is over. Although equity markets would take more time to scale the new peaks as at every gains now longs would look to take profits who earlier were adding longs at new highs. Therefore the recent slide in equity markets will not change direction of the higher equity, higher yield and lower USD view, but perhaps takes the momentum away for some time.

 

Today we have the RBI policy wherein the tone cannot be dovish given the higher CPI readings and increasing Brent prices. A hawkish tone will push bond yields higher and increase the problems for the government. I would assume that the RBI would therefore pay heed to government concerns and for the time being speak less hawkishly than what the market expects or the macros warrant. There could be some measures to alleviate bond market supply fears. These could be a roadmap to increase the FII investment limits into government and corporate bonds which can result in lower yields and appreciating INR post the policy today at 2-30PM.

 

USDINR 1m NDF is trading 1p right while USDKRW has moved higher to 1085 from yesterdays evening lows of 1077 (when INR was at 64.10). USD index could now head towards 88.5 again. While CNH has appreciated to 6.26 although it is less correlated to EM currencies in the recent past. CMP 64.17, Range 64.25-64.00.