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Bonds Rebound

Government bond prices bounced back on Friday as the Ayodhya tension eased off. The yield on the benchmark closed at 7.49 per cent. With RBI not in hurry to cut bank rate market is expected to be range bound.

Y. V. Reddy surprised the bond market on Monday by his statement that the bank rate could be cut "any day, any time". Consequently, the yield on the 10-year gilt touched a low of 7.51 per cent from its previous close of 7.60 per cent. The financial year-end considerations and developments at Ayodhya kept yields rising for the rest of the week to touch a high of 7.63 per cent on Thursday. But, bond prices bounced back on Friday as the Ayodhya tension eased off. The yield on the benchmark (11.03%, 2012) fell by 15 basis points on a single day to close at 7.49 per cent on Friday.

The funds requirement of the State Governments was met with the RBI issuing State Development Loans. RBI mopped up around 28 billion rupees from the sale of 10-year bond carrying an 8 per cent coupon. The RBI on Wednesday raised the cut-off price of the 91-day treasury bills at its weekly auction from Rs. 98.50 to Rs. 98.51. The yield at the cut-off price fell to 6.0668 per cent from 6.1081 per cent.

Call rates rose as high as 7.20 per cent on Friday on account of liquidity shortage caused by advance tax outflows. Finally, it closed at 6.90-7.00 per cent.

The rupee continued to stay calm. Backed by strong dollar inflows from foreign portfolio investors and steady remittances from exporters, the rupee ended the week at 48.71, gaining 3 paisa against the dollar. State run banks were seen mopping up excess dollar supplies to keep the rupee stable and augment foreign currency assets. The foreign exchange reserves touched $51.436 billion in the week ended March 8, up by $692 million in a week and $9.4 billion in the past 12 months.

Although, the date for the announcement of Monetary & Credit policy (M&CP) has been declared (April 29), the major highlight during the early trading session was the RBI deputy governor's statement that the bank rate could be cut any day any time. But, the governor who stated on Thursday that the Central Bank is not in a hurry to cut the bank rate clamped this down. However, he reiterated that the bias towards softer interest rates would continue. Currently, the bank rate is at 6.5 per cent. Last year bank rate was cut thrice (0.50 basis points each in Feb, Mar and Oct) and was reduced to 6.5 per cent from 8 per cent. It is at its lowest since May 1973. The rate cut is expected to ignite a fresh rally in the wayward bond market and enhance capital gains for bond and gilt funds. However, the rate cuts have not been as aggressive as in the United States, where the series of eleven rate cuts in 2001 brought down the key Fed Fund rate to 1.75 per cent, the lowest level in 40 years.

In an interesting move, private players have started reacting positively to the government's softer interest rate stance. For example, ICICI has lowered the interest on its ninth Safety Bond issue by 25 basis points. SBI is also likely to reduce its prime lending and deposit rates without waiting for a cut in bank rate by RBI.

Outlook
With a peaceful end to the Ayodhya imbroglio, sentiments seem to be upbeat on the bond market. However, call rate is likely to remain tight with more advance tax outflows next week. Besides, year-end consideration might force banks to book profit. But with RBI not in hurry to cut bank rate bond prices are likely to be range bound.