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Gilts lose their edge

Overheated gilts turned cold this week. Retrace from the discounted expectation of rate cut and anxiety around the annual budget took its toll on bond prices. Till budget, expect them to be wild but with limited downside and upside too.

Overheated gilts turned cold this week. Market turned jittery. Government bonds fell across the board. Many reasons: Hitch with the Negotiated Dealing System (NDS) introduced last week lingered; diminishing hopes of small savings rate cut; higher budgeted borrowing for the next fiscal; and likelihood of poor performance by BJP in elections in Uttar Pradesh. The growing consensus that small savings rate cut will be politically difficult. All this depressed the gilt prices. Participants were still getting used to the changed system. This showed in the dipping trading volumes -- less than Rs. 3000 crore a day in early sessions and to Rs 3300 crore even on offloading of long-positions.

After three consecutive days of firming up, the domestic currency fell by 9 paisa in the last trading session. Reversal caused by the foreign banks purchases of greenback for the overseas payment by clients. The call money hovered around 6.50-6.70 levels during the week. The rush to meet reporting Friday requirements by banks saw the rates spiral to an intra day high of 9 percent.

Banks Turn Contrarian: Interestingly, the Public Sector banks turned contrarian with upward revision their short-term deposit rates. Bank of India and Bank of Baroda revised their 45-180 days deposit rates by 50-75 basis points to 6.25-6.75 percent, emphasizing corporate mobilisations. On the other hand, banks generally seem reluctant to participate in government securities at all-time high prices.

Economic Update: Amidst gloom prophecies, a rather solid growth of core sector in January -- 5.9 percent has inspired optimism. But revenues remain poor -- the indirect tax: 65 percent below the budgeted estimate of Rs 1.3 lakh crore and direct tax: even worse with only 56 percent of targeted collection, till January end. As ever, government remains optimistic about bridging the gap in the two months left.

Outlook
Retrace from the discounted expectation of rate cut and anxiety around the annual budget took its toll on bond prices. And they seem headed nowhere till the budget. But higher oscillatory range looks imminent, given the outstanding positions in long maturity. Ofcourse, all this does not discount the timing of the rate cut.