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Bond Rally Takes a Breather

The high liquidity driven rally in sovereign bonds was derailed by the central bank's large-scale auction. With this RBI has been able to send a strong signal that it would not allow the market to get in the over drive mode.

The high liquidity driven rally in sovereign bonds was derailed by the central bank's large-scale auction. The cautious sentiment over the sustainability of lower yield during the earlier part of the week was replaced by euphoria even after the auction announcement. But finally RBI intervened to halt the falling yields. The government auctioned a 15-year maturity paper and a 8-year floating rate bond to the tune of Rs. 3000 crore each during the week. As the auction completes the government' s budgeted borrowing target through dated securities, the widespread expectation of this being a last one, pushed down the 10-year benchmark paper to a new low of 7.76 percent.

As the low yields were just 26 basis points above the average cost of funding for banks, RBI stepped in to absorb Rs 8000 crore through sale of two long-date government securities. But managed to flush out Rs 1350 crore as the players bids' at higher prices was rejected by the central bank. The open market operation strained out the liquidity overhang, as the gilt prices fell sharply by Rs 2 on the medium to long end of the maturity spectrum and the 10-year benchmark GOI edged up by 95 basis points from its earlier low. Besides this RBI's plugged out Rs 47815 crore through repo auctions during the week.

As the players covered up their reserve requirements much ahead of reporting week, call rates ruled steady within the 6.50-6.60 range, but ended a tad higher at 6.70 on account of open market outflows. Apart from a little weakening on the news of that Russia will cut back oil supply, rupee remained firm against the dollar on account of ample supplies from exporters.

The grinding fall in the G-sec yields spoiled the six week long party in the gilt oriented funds with an average gilt fund down 0.69 percent and a medium term debt lost 0.41 percent during the week. The biggest losers were the funds with a gilt holding as high as 40 percent as on November 30, 2001.

Outlook Unlike last week's open market operation of Rs 6500 crore which failed to dampen the bullish sentiment, this week, the central bank timed it right after a government auction of Rs 6000 crore and propped the yields from their historic lows. With this RBI has been able to send a strong signal that it would not allow the market to get in the over drive mode.