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Softening Interest

The unexpected Fed rate cut of 50 basis points and the over-subscription of the 7000 crore twin-bond auctions were the highlights of the week. Both these provided the market the necessary push to send the yields of medium and long-term gilts to lifetime lows.

After last week's euphoria, markets opened on a quiet note. In the initial two days trading was thin and the market was nervous in anticipation of the long-term twin bond auction. The yield on both bonds was set at lower than expected levels. The 17-year paper was two and half times over subscribed and its yield was set at 7.26 per cent. While the 24-year paper was oversubscribed by almost twice and its yield was set at 7.48 level.

Wednesday's Fed rate cut of 50 basis points, was far higher than market expectation. This fuelled a strong rally on Thursday. This coupled with the over-subscription of long-term bonds brought back life to the market, making yields fall across the board. The 10-year benchmark yield touched 6.785 per cent, a lifetime low on November 7. It finally closed at 6.82 per cent on Friday, 10 basis points lower then last weeks close. The latter part of the week also saw a lot of action on the long end of the curve making yields fall by 10-12 basis points.

The yield on corporate bonds also saw some seesaw action during the week. The five-year benchmark slid further over the last week and touched a lifetime low of 6.76 per cent The spreads between the five-year benchmark and the equivalent period gilt paper also shrank to 49 basis points.

After the two-bond auction liquidity tightened a bit. This was clearly depicted by an increase in the call rates on Friday to 5.6-5.7 per cent level. The repo auction bids were also low and the average auction size was 9700 crore rupees.

The Rupee ended 7 paisa up from the last week's closing of Rs 48.33. It closed at Rs 48.26 and has appreciated by 1.55 per cent from this year's low of Rs. 49.025 on 2nd May. Forex reserves also depreciated slightly to end at $ 64.039 billion.

The 50 basis point rate cut by Federal bank of USA gave a boost to domestic market. Though after the recent cuts, the RBI is not expected to follow suit. But this move has provided more leeway to the central bank to continue with its softer interest rate policy. This aggressive rate cut can also provide more dollar inflows from expatriate Indians, in search of higher returns.

Liquidity in the system is expected to ease up substantially with inflows from redemption and coupon payment expected be around 50000 crore. Yields are expected to be range bound through out the week.