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Too Much Liquidity

For a change it is the ample liquidity which forced traders on the backfoot. The deluge of foreign funds and consequent increase in liquidity has raised concerns of a possible CRR hike

Increasing forex inflows after the US Fed rate cut and the consequent disruption of equilibrium in the liquidity position has caused nervousness in the bond market. Traders fear a severe backlash from the central bank.

During the week the central bank even raised the ceiling on the market stabilisation scheme auctions to Rs 2,00,000 crore. The MSS auction is used to absorb liquidity created by the central bank's intervention in the currency market. As a result of the ambiguity on the central bank's stance, the bond market remained range bound through the week.

On Monday, October 1, trading was extremely thin. Dealers hesitated from taking positions ahead of the auction scheduled for Wednesday. Also by Monday dealers started expecting an upward revision in the ceiling of the MSS auction. Given the already large supply of bonds in the market a further supply would threaten profits. As a result the yield on the 10-year benchmark 7.99 per cent GOI 2017 bond remained unchanged from the previous close at 7.90 per cent. On Wednesday, there was some cheer in the market with the yield on the 10-year benchmark bond falling by two basis points. This was based on the belief that even a CRR hike would not put too much pressure on money supply. On Thursday the market remained unchanged from its previous close. But on Friday the mood turned sour. After market hours on Thursday the central bank raised the ceiling on MSS, in addition to this inflation for the week ending September 22 was reported at 3.42 per cent higher than the previous week's 3.23 per cent. As a result the yield on the 10-year benchmark bond ended unchanged from its previous week's close at 7.90 per cent.

While traders expect a hike in CRR, other developments go against such a move. For one thing there is a discernible decline in credit growth and the government will think twice before bringing credit growth under pressure; as this could potentially frustrate the progress of the economy. Inflation for the time being looks under control, which affords the government more freedom in intervening in the currency market.

In the light of a complete absence of positive cues, the bond market will remain subdued. Further given the jittery sentiment, bargain buying will also be limited. However, in the event of profit booking in the stock market leading to dollar outflows, one can expect a slight improvement in the bond market. But this could well amount to wishful thinking. As of now the coming week looks gloomy for the market.