Ever since the Wall Street Crash of October 1929, it has been noted that October tends to be a very volatile month for US financial markets and, by extension, global markets. Since 1900 that is, over the last 114 years, October has seen a huge range of swings. The Dow Jones Industrial Average (DJIA) has gone for a monthly maximum gain of plus 10.65 per cent and a monthly maximum loss of minus 23.22 per cent. The average move is much less at plus 0.2 per cent with 64 monthly gains and 49 losses. (Wall Street was closed in Oct-Nov 1914).
The causes of excessive volatility specifically in October are unknown. It could have something to do with the release of results in calendar Q3, or seasonal conditions in the US. However, whatever the causes, market participants know of the October effect. This means strong feedback loops occur when there’s volatility in October and the volatility is therefore, amplified by trader actions.
The Nifty and the Sensex are very closely correlated. This is not surprising since the entire Sensex set of 30 stocks belongs to the 50-stock Nifty and the methodology (free float market cap) is the same. These indices are also well-correlated to US indices, especially adjusted for time differential.
Mumbai is 10.30 hrs (630 minutes) ahead of New York. If one correlates the DJIA to the Nifty with that adjustment in mind, it becomes apparent that Mumbai trends often follow the previous session’s trend on NY. An index trader in Mumbai can check the DJIA trend at night as the NYSE closes, and assume a similar trend will occur on the NSE/BSE every morning, when Indian exchanges open. (He can also trade the Nifty on Singapore similarly).
October 2014 has seen sharp moves on US exchanges, and in currency markets. The Federal Reserve has stuck to tapering Quantitative Expansion 3, which ends this month. This has led to the dollar hardening, especially against the euro. The Euro Central Bank is expected to start loosening. Most traders fear that the Fed may raise policy rates inside March 2015. But when the minutes of the last American Federal Open Markets Committee meeting were released, it seemed that the Fed is unlikely to hike policy rates inside six months (October 2014-March 2015).
Still, there is an impact on all central bank policy. For instance, the RBI has to be braced for the possibility of a dollar rate-hike. RBI must have a dollar-rupee band in mind where it reckons the INR is comfortably valued. In that band, exports are competitive without essential imports being too expensive or external borrowings facing steep depreciation risks. It may need to trade dollars either way to keep the rupee in that band. It must also keep reserves in hand to manage potential volatility.
The dollar-rupee rate is most likely to be influenced in the short-term by FII attitude. Through October, the FIIs have sold. If that trend continues, the dollar will have a natural tendency to strengthen versus the rupee. RBI would need to prop up the rupee – it would probably intervene by selling dollar at some level above 62. Where exactly the central bank would intervene is guesswork.
A trader could go long dollar-rupee, while watching for RBI intervention like a hawk. Or, he could rely on the correlation between DJIA and Nifty. The RBI has done unorthodox things under Raghuram Rajan and in any case, the trader must guess at what the RBI considers a reasonable dollar-rupee band. The DJIA-Nifty correlation may be more reliable for a trader.
The author is a technical and equity analyst
