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Bonds Bounce Back with a Vengeance

With a string of positive tidings, yields have dipped to pre-attack levels. With the rupee stabilising, the market is again pinning hopes for an interest rate cut.

After the bruises, comes the balm! Battered bond markets received a much-needed respite this week after a troubled fortnight of volatility and sharp losses. The string of sops and positive developments triggered brisk buying for attractively priced bonds. The rupee also started the week on a strong note with a 13 paise recovery after it had slumped to a historic low of 48.43 on September 17. The domestic currency remained stable against the greenback for the week at 47.86 levels.

While bonds posted healthy gains, profit booking emerged towards the end to spruce up returns just before the half-year closure. Nonetheless, the sharp surge in bond prices has seen JP Morgan G-Sec Index recoup its losses in the aftermath of terrorist attacks in the US. The index, which had slumped by over 2.5 per cent, is now back to its September 11 levels.

Bond bulls had substantial fodder this week as the removal of US sanctions coupled with a 1% cut in interest rate on export credit bolstered sentiment.
The cut further spurred hopes for a reduction in the more significant bank rate with the finance minister also expressing his bias for lower interest rates.
The shift in US policy from military action to diplomatic channels aided fresh buying as fears of an immediate war receded.
The Reserve Bank continued with its buyback of bonds to infuse liquidity in the markets, pumping nearly 5,000 crore in the last fortnight. Support also came in form of reverse repos.
There was more good news in store as oil prices crashed to $21.70 per barrel, largely driven by fears of a lower demand due to a faltering global economy. While oil prices inched up towards the weekend, they are still way below the normal band of $26-27 per barrel.
The slump in oil prices is positive for the markets. One, it will ease off the pressure on the rupee and two, reduce the oil pool account deficit since a 1$ fall in oil prices lowers import bill by Rs 200 crore. However, it remains to be seen whether prices would stay at current levels or OPEC would pull them back to the $26-27 cordon.
The week saw sharp spurt in advance corporate tax collections, which turned positive for the first time in the current year. So far, bond markets were faced with the grim prospect of a fall in revenue collection, which would have pushed up government's borrowing for the year. The buoyant inflows also mean that the government may not immediately tap the markets with an auction.
The government again seems to be getting its act together on the vexed issue of disinvestment with its plan to sell 13 PSUs in the current fiscal. Though the target is certainly ambitious, even a few sell-off will boost market confidence and reduce borrowing pressure.

However, the week had its share of negative tidings as well. The first quarter GDP grew by only 4.4 per cent against 6.1 per cent for the same period last year. While both agriculture and services sectors showed robust growth, the manufacturing sector took a big knock with growth petering to 2.3 per cent against 7 per cent last year. Worse, the fiscal deficit is already nearing 50 per cent of the target set for the current fiscal due to a mix of higher expenditure and lower revenue.

Outlook
While war clouds seem to have dispersed for the time being, the undertone is still cautious. A sudden escalation in confrontation has the potential to derail sentiment. Going forward, the markets are likely to be guided by US reaction in the troubled region and hopes for a rate cut. While yields have sunk to pre-attack levels, a sustained positive trend could further drive up bond prices.

Already, a number of Asian countries have lowered interest rates after Fed's 50 basis points rate cut to boost sagging economies. In fact, the deceleration in the manufacturing sector, which has been the worst quarterly year-on-year performance in the last 10 years, could now put more pressure on RBI to directly lower interest rates.