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Lull before the Storm

Trading volumes remained low and bond yields closed the week largely unchanged. Market participants are eagerly awaiting Monday's Monetary Policy. Expectations of a bank rate cut are in the air.

Ahead of Monday's Monetary Policy, Indian bond yields remained choppy this week. The open market sale of Rs 1,000 crore resulted in some liquidity tightening in the early part of the week. But liquidity conditions improved in the latter half of the week, which led to the rise in bond prices. As a result, the yield on the 10-year benchmark (GOI 2013, 7.27%) after touching a high of 5.16 per cent on Tuesday, ended the week at 5.09 per cent on Friday – down 2 basis points.

Though bond yields came down in the last two trading sessions, the overall market sentiment remained cautious ahead of the monetary policy. The weekly average trading volume in the Wholesale Debt Market stood at Rs 3,700 crore this week against Rs 8,000 crore two weeks back.

Liquidity was under some pressure as the central bank sucked out Rs 5,700 crore through OMO and 28-day repos last week in addition to the schedule auction of Rs 5,000 crore. The liquidity was further affected by the OMO of Rs 1,000 crore this week. In support of this move, the RBI deputy governor Rakesh Mohan said last week that these moves were to manage expectations. This in turn has put a question mark on the possibility of a repo rate cut in the monetary policy.

Due to tight liquidity, the RBI rejected repo bids on Wednesday and Thursday. But as liquidity improved, though marginally, RBI accepted all the repo bids for Rs 5,500 crore on Friday. The call rate too shot up to 6.25 per cent on Wednesday but came down later. Interestingly, the call rate fell to 2-3 per cent on Friday evening. This was mainly because the last trading day was a reporting Friday and banks had maintained the CRR requirement in the morning. There was thus no more demand for funds in the evening.

A rise in inflation is also a cause for concern in the bond market. The inflation based on Wholesale Price Index rose to 5.01 per cent in the week ended October 18 from 4.95 per cent in the previous week. Inflation is expected to go up further if the economic activity gathers momentum.

The rupee remained unchanged at Rs 45.32/$ over the week. However, it touched a low of Rs 45.38/$ on Monday, but rose later boosted by steady forex inflows. The RBI has been mopping dollar inflows, which has in turn boosted foreign exchange reserves to a record level. For the week ended October 24, India's foreign exchange reserves rose to $91.89 billion from $91.32 billion in the previous week.

Outlook
Market is likely to get direction from Monday's monetary policy. Though the market is not optimistic on the repo rate cut, a reduction in bank rate and Cash Reserve Ratio (CRR) are expected. If this happens, it will turn out to be party time for bonds and bond fund investors. For now, over to Mr. Y. V. Reddy.