Greater clarity on the participatory note issue was received better than expected by the bond market. While last week traders were concerned about the effect on liquidity owing to the embargo on inflows, this time round the liquidity concern was overshadowed by the possible leniency in monetary policy. The relation goes like this: If indeed inflows slow down, the appreciation in the rupee will stall. As a result the central bank will not be compelled to intervene to stem the rise in the rupee, thereby containing the amount of money floating in the system. This in turn will do away with the need for market stabilisation bonds as well as a CRR hike.
In addition to this, speculation on yet another US Fed cut on October 30 strengthened further. This would put pressure on the central bank to cut its key lending rates in the medium term. As a result of these positive developments, the 10-year benchmark bond showed visible gains. The yield on the 7.99 per cent GOI 2017 bond fell by as much as eight basis points since its previous close. The fall in the yields was steady throughout the week, with the biggest fall seen on Tuesday. However on Friday there was some weakness in sentiment owing to oil prices that touched an all time high. Reported inflation as on October 13 was 3.07 per cent unchanged from last week.
Bond prices have recovered the losses from the time that a CRR hike was almost certain. The extent of the US Fed rate cut will determine the arbitrage in interest rates. And depending on the inflows owing to this, the central bank will decide on whether it can afford to revise rates downwards. But high oil prices are likely to play spoil sport and ruin the inflation party. This will prevent the RBI from softening its monetary stand. Yet, there is clear optimism in the market. And a rate hike is highly unlikely. Looks like good days are back for the bond market. One can expect Monday to be subdued. Bonds could rally on Wednesday, taking cues from the US Federal Reserve's policy review slated for October 30.