It was a week of high activity as well as big volatility in the Indian bond market. It started with excitement and bullishness on the back of 0.5 per cent cut in the repo rate. But rumours that the RBI is not comfortable with a flat yield curve once again spoilt the party later in the week. Nonetheless the gains on the surprise repo rate cut saw the yields move down by 20-36 bps over the week. The benchmark 10-year yield fell sharply from the previous week's close of 5.56 per cent to 5.23 per cent early this week. It edged up by Friday to close at 5.26 per cent.
The government bond yields had closed on a volatile note with a sell-off in the previous week when the RBI governor stated that a flat yield curve was under review. But the market did not expect that the RBI would take the repo rate route to address the issue of the flat yield curve. This indeed led to widening of spreads between short and long maturity government bonds as short-term bonds fell faster than the latter. On Monday, the spreads between 1-10 year and 5-15 year maturity gilts widened by 19 bps and 13 bps respectively. Later in the week, long-term gilts also rolled down faster, but profit-booking clamped gains. The euphoria over the rate saw the 12-year state loan auction go smoothly.
RBI also came out with its annual report mid-week, which indicated bullishness on the macro fundamentals and economic growth, which arrested the sell-off and bond prices remained steady. The apex bank stated that even if credit demand picks up, capital inflows will keep interest rates lower in the current fiscal.
But the markets once again took a U-turn. RBI set the yield on the 91-day T-bill auction at 4.74 per cent, while its secondary market yield was 4.67 per cent. As a result, market participants sold off short-tenure bonds, leading to higher yields from Monday's level. Besides, rumours that an RBI official had said that the yield curve is not steep saw the long-term bonds slip on Friday. The net result: from the post-repo rate cut level, short-term government bonds inched up, while the longer ones nudged lower. Thus once again, we are back to a somewhat flat yield curve.
The overnight markets stayed calm despite the state loan auction. On the forex front, the blasts in Mumbai saw the rupee fumble as it depreciated by 7 paise on Monday. Though it resumed its upward journey, corporate demand and dollar purchases by PSU banks prevented any sharp rise. The rupee finally closed a tad lower from its previous week's level of Rs 45.83 to a US dollar.
Outlook
During the week, the apex bank has clearly demonstrated its bias towards soft interest rates and the bond markets have cheered that. At the same time, it has converted special securities worth Rs 19,000 crore into bonds, which indicates that it is arming itself for an open market sale. This dampened the market sentiment and thus going forward, the fear of open market sale may prevent any runaway fall in yields.
Historically, September has been a dull month, as banks usually book profits ahead of their half-yearly book closure and corporates have to make advance tax payments too. Bond yields are likely to move in a narrow range.
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