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A Free Fall

The yield on the 10-year benchmark fell below the bank rate. With RBI being comfortable with the lower yields, bond prices are likely to continue their northward journey, provided the central bank doesn't throw a spanner in the form of an OMO.

The liquidity-driven rally continued to push bond prices up. The yield on the 10-year benchmark (7.40%, 2012) GOI security fell below the bank rate and ended the week at 6.22 per cent – down 10 basis points (bps). Though the yields firmed up marginally on Tuesday, following the auction of state government securities, but it couldn't put brakes on falling yields for the remaining trading sessions. The higher cut-off yield set at the 364-day T-bill auction too failed to make an impact on the market.

However, during the intra-day trade on Friday, the yield on the 10-year benchmark touched a low of 6.2 per cent. The RBI governor's outlook for inflation being uncertain owing to volatile oil prices due to a possible US-Iraq war, saw the yield move up to 6.22 per cent.

Softer interest rate bias and absence of any OMO announcement attracted buying interest in the market. The daily average trading volume, however, remained lower than the previous week's level. Much of the trading was concentrated at the longer end of the yield curve. While the yield on the 15-year (8.07%, 2017) GOI security fell by 12 bps, the yield on the 20-year (8.35%, 2022) GOI security dropped by 20 bps.

On the other hand, corporate bonds weren't far behind. The yield on the 5-year benchmark Nalco paper fell below the bank rate and ended the week at 6.24 per cent. The spread between the 5-year AAA bond and similar-maturity government securities narrowed from last week's spread of 36 bps to 31 bps on Friday. Thus, unlike last week, yield on corporate bonds fell sharply vis-a-vis gilts.

The auction of state government bonds, which had little impact on the bond market, did affect the call money market, though marginally. Excessive bidding led to a liquidity squeeze in the market, with call rates touching a high of 6.35 per cent on Monday. But the refund of excess bids boosted liquidity in the market. The call rate finally closed in the range of 5.60-5.75 per cent on Friday. This liquidity tightening was also reflected in Rs 1,813-crore average daily outflow towards repo auction. This was one-fourth of last week's amount.

In the forex market, the rupee gained one paisa against the dollar. State-run banks, on behalf of RBI, bought dollars heavily during the week to check rupee appreciation. As a result, the rupee remained weak on the first four days. However, with huge dollar inflows from corporate and exporters ahead of the year-end, the rupee ended the week at a new one-year high of Rs 47.99/$.

Outlook
The RBI governor has reiterated that he is comfortable with the lower yields owing to low inflation and increasing forex reserves. Thus, bond yields may continue their downward journey in the absence of the central bank's intervention. However, the market may go in for a mild correction ahead of the Rs 5,000-crore auction of 10-15 year GOI securities scheduled for January 1-6. Therefore, much of the activity is likely to be concentrated at the medium to long-end of the yield curve.