Foreign investors are heading into the Union Budget presentation on February 1 with considerable pessimism.
While the pessimism of foreign portfolio investors may not be entirely linked to the outcome of the Budget, it will have a considerable impact on how the market may behave on the day of the announcement and for the rest of February.
“There is extreme positioning in the market heading into the Budget. FII is aggressively shorting but retail and HNI have build-up large long positions on the index (Nifty 50),” said Bhavin Mehta, vice president at Dolat Capital Markets.
The long-short ratio, an indicator of sentiment among foreign investors in the equity derivatives segment, collapsed to 0.49 at the beginning of the February derivative series from nearly 2 at the beginning of the January series, data collated by Moneycontrol showed.
Foreign investors are starting the new derivative series with net shorts of 43,506 contracts on the Nifty 50 February futures reflecting their considerable pessimism for the Indian equity market in February. The driving force behind the negativity is the fear of considerable hikes in interest rates in the US and a possible contraction in the US Federal Reserve’s balance sheet later in the year.
On January 26, the US Fed Chairman Jerome Powell told the media that the US labor market was strong enough to withstand rate hikes while he also suggested that the tightening cycle this time around will be different from those seen in the past.
Brokerage firm Nomura now expects the US central bank to raise interest rates five times in the calendar year starting with a 50 basis points hike at the March monetary policy meeting. “Powell’s comments suggest the FOMC is beginning to coalesce around a more front-loaded policy rate response to elevated inflation, wages, and inflation expectations,” the brokerage firm said in a note on January 27.
The pessimism of FPIs is also visible in their position in the options contracts of the Nifty 50 index. FPIs increased their long positions in the put options of the Nifty 50 by 82,681 contracts while they enhanced their short positions in call options of the index by 72,219 contracts.
A put option gives the buyer an option, not an obligation, to sell a security at a pre-determined price and time. A call option gives the buyer an option, not an obligation, to buy a security at a pre-determined price and time.
Taking a contrarian stance to foreign investors, retail clients are heading into the Union Budget with net long positions on the Nifty 50’s February futures of 68,592 contracts, which is considerably higher than the net long bets of 5,336 contracts at the beginning of January futures and options series.
A post-Budget short squeeze in the offing?
Market participants are fairly confident that the Union Budget will not throw any curveballs towards investors and will stick with the expected narrative of growth push and fiscal prudence.
“We believe the government will focus on gradual fiscal consolidation while pushing public capex, creating a conducive environment for private capex, and raising resources via strategic divestments,” said brokerage firm Morgan Stanley.
The considerable quantum of short positions by foreign investors on the Nifty 50 futures contract for February makes them vulnerable to a brutal short squeeze if there are positive surprises in the Union Budget.
A short squeeze is a scenario wherein the price of a security moves sharply higher forcing participants who bet on its fall to hurriedly cover their losses, which in turn shoots the price even higher.
Derivative analysts are, however, skeptical of any short squeeze and do not expect the Budget to have much say in the direction of the market going ahead. “The way they are shorting the market, clearly FPIs are not at all looking at the Budget but beyond it. The extent of selling from them is making me cautious,” Mehta said.
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