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Retired Hurt

Gilts were losers this week. The yield on the 10-year benchmark ended at 7.81%, up 6 basis point over the week. With no auction due for the month, bonds could be in for a brief rally.

Gilt markets opened the week on a good note with comfortable liquidity in the system. Owing to the upbeat sentiment in the market gilt prices rose by 25-30 paisa on Monday but fell subsequently by 10 paisa on account of profit booking at higher levels. Gilt prices continued to slide through the week, though marginally, bringing to a halt the upward journey gilts had witnessed in the past two weeks. The yield on the 10-year benchmark (11.03%, 2012) rose by 6 bps over the week, to close at 7.81% on Friday. The wholesale debt market saw low aggregate trading volume, reflecting the investor's caution over which way yields were headed.

After the scheduled Rs 6,000-crore government paper auction outflow -- which put downward pressure on gilt prices -- gilts witnessed a minor rally on Thursday. The reason: the cut-off yield for the newly-issued 10-year paper was in line with the secondary market yield. However, the rally was short-lived, as primary dealers sold off securities devolved on them at the auction, leading to a fall in bond prices. Market sentiment was further affected by the fear that RBI may go in for an OMO sale to suck out excess liquidity.

Amidst ample liquidity in the system, created also by an inflow of Rs 6,000 crore through a CRR cut on June 1, call rates hovered in the 6-6.20% range throughout the week. Last week, call rates closed below the refinance rate of 6%. The surplus money amounting to Rs 44,342 crore went into RBI's repo auction.

As for rupee it gained 2 paisa over the week. However, it touched a low of 49.04/$ on Monday as there was less dollar inflow on account of some export order cancellation and regular demand by importers. Rupee rebounded and closed at 49.02/$ on Friday backed by huge dollar inflows and waning war fears.

On the economy front, it is expected that inflation would rise in the coming months. The rate of inflation has been hovering around the 1.5% level for some time. With oil prices moving up, inflation could go in for a correction (upward). Further, government's decision to reduce excise duty should provide some relief to oil companies. It has been decided that oil prices will be revised every fortnight and the excise duty will be revised every quarter, which will take care of any volatility in international oil prices.

Outlook
With no auction due for this month, bonds could be in for a brief rally. However, owing to comfortable liquidity, we can't rule out an OMO, which could hurt bond prices. Further, an escalation of border tensions could change things completely.