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Caution Rules the Bonds

After considerable flip flop in the market, bond prices broke their rising streak. Traders expect a rationalization in the level of liquidity after the impending monetary policy review

The gung ho mood in the government bond market was finally tested last week. The week started on an upbeat note, on the back of lower than expected quantum of market stabilization scheme. In spite of marginal profit booking witnessed on Monday, the yield on the 10 year benchmark 7.49 per cent 2017 bond fell by six basis points from its previous close.

However on Tuesday, traders got a little jittery, fearing a backlash from the central bank in curtailing excess liquidity in the system. While there was a broad consensus in the trading fraternity that RBI will leave rates unchanged in its month end policy review, there was uncertainty on the severity of the alternate measures that the central bank will resort to. As a result the yield on the benchmark bond corrected by eight basis points over Tuesday and Wednesday.

On Thursday, traders built up positions to some extent expecting lower inflation, this took up yields marginally. But on Friday a nervy market reversed these gains. Reported inflation also stood higher at 4.41 per cent for the week ending July 14. The yield on the 10 year benchmark bond finally ended flat at 7.84 per cent, up three basis points from last week.

After trading hours, the central bank announced it would auction Rs 5000 crore of market stabilisation scheme bonds on August 1. Sticking to its borrowing calendar, the government will also auction another Rs 10000 crore of bonds on August 3.

Outlook
The central bank is unlikely to pull a surprise on the market. The market expects the central bank to lift or remove the current Rs 3000 crore cap on reverse repo auction. The immediate fall out will be both a higher short term rate and long term rate. Based on this expectation the bond market has corrected to accommodate this move. However, it remains to be seen whether the central bank does indeed implement any change here. Either way the effect on bond yields should not be too drastic as part of the adjustment has been already accommodated.