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Gilts: Making Merry

The yields were in a relaxed mode once again this week, notwithstanding the OMO fears. The apex bank says it doesn't plan an OMO in the near future. Will it stick to its word while yields continue to fall?

Debt markets continued their joyous rise even this week. The reason: the same as last week -- ample liquidity in the system. Excess funds continued to flow into repo deals (aggregating Rs 45,162 crore) despite the repo rate cut, while call rates hovered around the repo rate, of 5.75%. On the other hand, the gilt yield curve moved down by 6-12 bps with the sole exception of short-tenure gilt yields (2 and 3 years), which firmed up marginally. However, it was medium-term securities that attracted maximum trading since the spread between short-to-medium-term securities was higher than that between medium-to-long-term. For instance, till last week, the 10-year benchmark was quoting at 125 bps above the 364-day T-bill yield of 6.36%, while the 20-year paper was quoting at 100 bps against the 10-year benchmark.

Although the week started off on a bullish note but all eyes were fixed on the cabinet reshuffle. The sentiment turned further upbeat with the RBI setting the 7.55% GOI 2010 yield at 7.30%, marginally above market-anticipated 7.28%. However, the 15-year floating rate bond auction worth Rs 3,000 crore devolved on the RBI by Rs 1,150 crore. Till mid-week, the yield on the actively-traded 7.40% GOI 2012 was down 2 bps (7.40%) over the last week's level. Falling yields forced players to think perhaps the RBI would step in to squeeze out excess liquidity. However, the apex bank gave assurance against an OMO operation. Still, the cautiousness prevailed and the 7.40% GOI 2012 settled around 7.41%. In fact, towards end-week, market interest had shifted to the illiquid segment. Case in point: 12.29% GOI 2010, which was last traded at 7.83% on June 26, 2002, dropped by 16 bps (7.66%) at close.

On the rupee front, the currency's upward journey vis-à-vis the dollar was brought to a halt on Friday on account of demand from importers. After rising to a high of Rs 48.79/$, the domestic currency closed the week at Rs 48.83. Despite an appreciating dollar in the international market, the rupee gained 5 paisa over the week.

Meanwhile, with the economy looking up, the new chief executive of the finance ministry, Jaswant Singh, faces the daunting task of putting brakes on the high fiscal deficit, irregularities in regulations, etc. Already, a couple of days in office Mr FM has bolstered people's confidence by expressing his willingness to scrap the service tax on insurance. We wish you all the very best Mr Singh.

Outlook
Despite the central bank's assurance that it does not plan to conduct an OMO, the bond markets acted cautiously. Even next week, this cautiously optimistic rally is expected to continue. Further with the government's Way and Means Balances (WMA) till June 28, 2002, falling by Rs 2,721 crore over the previous week's level, there is little likelihood of an out-of-schedule bond auction.