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What Goes Down Comes up Also

The uncertainty and fear of change in RBI's soft interest rate stance loomed large on the debt markets and gilt yields witnessed a sharp surge. It could continue like this untill some good news flows in

Bond markets witnessed one of the most volatile weeks in recent times. With trading volumes dropping by 25 per cent over the week, the yield on the 10-year benchmark government security (2013, 7.27%) reached its two-month high of 5.16 per cent level, only to scale back to 5.10 per cent—marginally higher than last week's closing level.

Bond market participants were already in a dilemma over whether banks' investments in mutual funds come under unlisted bonds category and have been waiting for a clarification from SEBI. Besides that, the market is quite worried that the strong economic growth will ignite a rise in interest rates. This has put most of the buyers on the sidelines. With this nervous sentiment, the markets reacted and tried to decipher every word of RBI officials over the week.

An RBI official statement that the apex bank could raise or lower the cash reserve ratio in order to manage liquidity sparked off a rise in yields. Cash reserve ratio is the percentage of funds which banks are supposed to keep with the RBI. A hike in this ratio can limit the available funds with banks and in turn reduce the demand for gilts. Lowering of the CRR in turn increases the available funds with banks, which in turn increases the demand for gilts. Following the comment, the yield on the 10-year benchmark (2013, 7.27%) rose by nearly 7 basis points to 5.16 per cent on Tuesday. However, RBI governor's statement that CRR may be cut to the desired 3 per cent level over the medium-term came as a soother and the 10-year yield came down to 5.10 per cent. Moreover the news that government doesn't plan to borrow in the near-term under a debt-swap scheme also propped up the sentiment.

Though the yields came off the peak, the nervousness prevailed as trading volumes in later half of the week hovered around Rs 3,200 crore against previous week's average of Rs 4,370 crore. Even the fall in WPI-based inflation from 5.01 per cent to 4.88 per cent over the week ending November 8 didn't lead to any enthusiasm. During the week, the medium-to-long term gilts were at the receiving end as these securities' prices fell in the range of 50 paise to a rupee. As a result, the GOI spreads have widened not only over the week but also since October 16, when the 10-year benchmark had dropped below 5 per cent. The 10-15 year spread, which stood at 0.32 per cent on October 16, was 0.45 per cent till previous week and has now expanded to 0.53 per cent. Widening spreads are an indication of steepness in the yield curve.

In the money markets, liquidity continued to be abundant as the repo inflows were in excess of Rs 18,000 crore and overnight call rates ranged below the repo rate of 4.50 per cent. However, the rupee continued to slide against the dollar for second consecutive week. Uncertain about RBI's stance on the exchange rate policy, many corporates and importers were believed to be hedging their dollar requirements, thereby leading to a shortage in the greenback. The domestic currency lost 43 paise over the week to end at Rs 45.84.

Outlook
The bond markets could remain on sidelines until there is a clarification over the definition of unlisted bonds for banks.