The Rupee Squeeze

What an u turn we have seen – of people of all manger of expertise who once extolled the decoupled state of Indian economy during the erstwhile “India Shining” days who are now weighing in with stories of markets being joined at the hip! Local stories do little to educate on what is happening and is going to happen (!) in our local markets. Most local commentators worth their salt correctly look to charts of the SPX, USD, credit in the US etc. as reliable portends of the shape of things to come. The de-couplers of past were certainly wrong – they ignored the big glue that sticks us (and other emerging economies) together with the rest of the birds flying at the head of our skein. That glue, is undoubtedly the currency exchange rate. Take a look at the comparison of the NIFTY vs the DEFTY chart below. I have also charted the ratio of DEFTY over NIFTY – since 1994 each unit of NIFTY is getting you progressively lesser and lesser quantities of DEFTY, indicative of a massive squeeze on the INR.

The human eye searches for patterns where there ought to be none! My untrained eye seems to suggest a great support at 3,000 on the DEFTY. We are ~3,350 currently, so a nice 10% correction would get us there. Possible? I don’t think any expert would be foolhardy enough to put a zero probability for that happening. So, either the INR rises in the immediate term or the market falls on disappointing results or both happen to get the DEFTY down to this level. But yes, as far as patterns and psychological levels of supports go, the 3k mark does provide a nice breather.

So if you are trading, the USD:INR is obviously a huge factor to consider. The graph on the right plots the correlations between N day returns (on a given day) and the immediately following Nth day return. The blue line is for the NIFTY N day return correlations while the red line shows this relationship for the DEFTY. For positive value of correlation coefficients, one can expect that given a positive (negative) N day return, the next N day return will also be positive (negative) – i.e. the tendency for the trend to continue. Both the NIFTY and DEFTY data suggests that this correlation peaks at N = 10, implying that given a 10 day trend, it is most likely that the following 10 day period will stay true to that trend. The point here is that from an overseas investor perspective, the relationship is more pronounced as compared to the internal view. NRIs are raking it all in!! Hopefully some of them will fill our reserves with their precious FCY and buy houses here.

Please note – this is median behavior, the N day returns are likely to show a normal distribution with some really fat tails (9/11, bombing of Parliament, Lehman event, etc.). the chart below shows the rolling 10 day return on the NIFTY over time and its 50 period moving average line. The outliers (i.e. the fat tails of the N = 10 day return normal distribution curve) are as high at 26.8% on the positive side and as low as 27.7% on the negative side!! Shouldn’t trading be an Olympic sport?