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Bull Rally Refuses to Halt

With central bank's soft stance at the interest rates, while the yields touched a new historic low once again, the apex bank may resort to open market sale to mop up excess liquidity

Even an auction outflow of Rs 4000 crore undeterred the southward movement of the sovereign yield curve. With the RBI governor stating its comfort with the interest rate levels, the yield on the 10 year (2011, 11.50%) benchmark paper touched a fresh low of 8.10 percent during the week. The ample liquidity and little demand for funds led the overnight interest rates range between 6.50-6.75 percent, despite the beginning of reporting Friday. On the other hand, the repo activity gained momentum this week, as participants parked in Rs 30,310 crore with the Reserve Bank of India. The Indian rupee pierced the 48 mark, after Fitch downgrade of country's foreign currency outlook.

The coupon on the new floating rate bonds worth Rs 2000 crore auctioned during the week, was set at a spread of – 0.05 percent as against the higher expectation by the market. The issue garnered huge response, with ICICI cornering 75 percent of the deal in its run-up to meet the post-merger SLR requirements. As the coupon on the floating bond will be set every six months, the instrument is expected to be used more as a hedging instrument as well as a benchmark for the short-dated securities, where trading interest is low.

Driven by fears that low gilt yields will not sustain for long, the market activity shifted to corporate bond segment, where the volumes surged to Rs 137 crore midweek. The AAA rated corporate bond offers yield, which is 145 basis points above the similar maturity government paper. Although markets shrugged off the the currency downgrades by two rating agencies, but succumbed to the suggestions of removing the cap on government's fiscal and revenue deficits, as proposed in the Fiscal Responsibility Act. Ironically the downgrade came on the concerns over government's ability to contain its fiscal deficit and implement reforms. But the finance minister reiterated the government's conviction to pass the bill without any eliminations.

Further the bad news continued to pour in this week as well, as the economy's core sector registered October growth of mere 2.2 percent as compared 10.7 percent during the same time in 2000. While cement and steel sector were the key industrial growth drivers during October, a 16 percent jump in commercial vehicles reflects the pick-up in demand. Still it's the credit offtake, growth in exports and the fiscal movement, which will chart the economic recovery.

Outlook
While RBI statement has given a leeway to markets to decide the movement of yields, an auction announcement by government to meet the interest and redemption may further soften the yields over the short term and bring about trading interest in corporate debt segment as well. Or the apex bank may resort to open market sale of government securities to cool down excess liquidity.