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Treading Cautiously

Inching up on some positive news and moving down on unfavorable news, bond prices moved in a narrow range during the week. Liquidity in the system continues to be in abundance. So, are we headed for a brief rally?

Cautious is the word to describe the mood of Bond Street during the week. Despite comfortable yields (read: according to market expectations) at the twin auction and the government flushed with funds owing to RBI which transferred close to Rs 10,300 crore as dividend payout, bond prices gained around 15-50 paisa around the medium-to-long end of the curve. With Rs 7,000-crore unscheduled auction, government, while taking advantage of lowest-ever interest rates, has completed 51% of its net borrowing target of Rs 95,859 crore.

At the start of the week, apart from the pre-auction fears about the cut-off yields and liquidity, markets kept a close watch on the government's reaction to attacks in Kashmir. However, with finance minister contemplating bringing down PF rates saw bond prices move up. This was further bolstered by the 15-year, Rs 4,000-crore paper getting devolved up to Rs 2,440 crore on primary dealers and RBI. Market participants construed this as the apex bank's unwillingness to dampen liquidity.

However, with Mr Jalan dashing all hopes of another repo rate cut, bond prices went in listless mode towards the weekend. The 10-year benchmark 7.40% GOI 2012 firmed up to 7.37% before settling around the last week's close of 7.33%. As for action on the corporate bond mart, the benchmark top-rated 5-year paper dropped by 22 basis point as against a marginal 3 bps drop in the similar-tenure government securities (GOI 2007 11.90%) over the week.

Despite a 25 bps repo rate cut towards June-end, the average daily repo auction outflows in July (till July 19) stood at Rs 14,000 crore, as against daily average of Rs 7,493 crore in June. Comfortable liquidity can also be gauged from the call rates, which have largely hovered around the repo rate of 5.75% in the current month. Markets had anticipated that the apex bank would bring down the repo rate from this level as well, which RBI hasn't given into.

On the forex front, the attacks in Kashmir hurt the exchange rate as well. The Indian rupee started off weak at Rs 48.83 to a dollar, however, gained ground on the back of sustained dollar inflows. On the other hand, dollar continued to slip against the euro and the yen, as US witnessed fresh accounting scams.

With the government receiving Rs 10,300 crore from the RBI in the form of dividends, it should take care of the former's expenditure for the rest of the month. Hence, we expect bond prices to move up, notwithstanding the RBI OMO. The next auction of Rs 8,000 crore is due in the first week of August. Government as a customary practice has borrowed 51% of the targeted amount in the first four months of the fiscal. So, the possibility of exceeding the target can't be ruled out.