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A Cheerful Market

In a high trading week, bond prices rose by 40-80 paise due to comfortable liquidity and increasing hope of a bank rate cut. The outlook seems favourable as banks will resume buying government securities in October.

It was a good week for the bond market. After a gap of almost a month, the yield on the 10-year benchmark (GOI 2013, 7.27%) fell to 5.25 per cent this week -- the level, which was achieved after the repo rate cut in August 23, 2003. Interestingly, this was accompanied by a higher daily average trading volume of Rs 5,840 crore – a rise of 18 per cent over previous week.

The benchmark yield touched a high of 5.31 per cent following the rise in inflation and profit booking by state-run banks ahead of the half-yearly closing of accounts. But later in the week, easy liquidity and increasing expectations of a bank rate cut in the forthcoming monetary policy led to the fall in bond yields.

The bank rate cut hope got a further boost after the RBI governor's comment that economic growth would be aided by benign inflationary conditions, adequate liquidity coupled with soft interest rates and a strong external sector. The market sentiment remained buoyant following RBI's assurance last week that the redemption of Resurgent India Bond (RIB) would not impact liquidity in the market.

After two weeks of relatively tight liquidity following the advance tax outflows, the liquidity in the market improved this week. This was widely reflected in Rs 20,000 crore average daily subscription to RBI repos – an increase of 20 per cent over previous week. The call rate too remained below the repo rate of 4.5 per cent throughout the week. This week, the bond market saw an inflow of Rs 2,266 crore from coupon payments and redemption of government securities and treasury bills.

Though yields fell across the board, the fall was sharper at the short-tenure bonds. Consequently, the spread between the 5-year and 10-year government securities widened to 0.44 per cent this week against 0.37 per cent last week. The yield curve became steeper this week over previous week.

The rupee gained 9 paise to close at Rs 45.85/$ on Friday. On Monday, the rupee touched a high of Rs 45.75/$, following the strong foreign fund inflows and the weakening of the dollar globally. But the uncertainty over the impact of RIB redemption turned the rupee weaker towards the weekend. Though RBI has assured a smooth outflow of $5.5 billion redemption of RIB, traders are still cautious that it may cause temporary cash dollar shortage in the market.

Outlook
With couple of holidays in the coming week, trading activity may remain low. However, the outlook is favourable for the bond markets, as state-run banks would resume buying government securities in October. These banks have been major sellers in the last few weeks ahead of the half-yearly account closing. But an increase in inflation could play spoilsport.