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US Fed Cheers, BoE Disappoints

Though the unchanged US interest rate and favourable exit poll predictions cheered debt markets, the rate hike by Bank of England (BoE) played spoilsport. The yield on the 10-year benchmark closed the week at 5.12%.

It was an eventful week for the Indian bond market. Initially, the market sentiment was cautious ahead of the US Fed meeting. But with the US Fed keeping interest rates unchanged at 1 per cent, along with favourable exit poll predictions for the NDA, the markets got a big lift. However, this euphoria was short-lived following the rate hike by Bank of England and the rise in global oil prices. As a result, the yield on the 10-year benchmark (GOI 2014, 7.37%), after touching a low of 5.10 per cent on Thursday, rose to 5.12 per cent on Friday – down just a basis point over the week.

On Tuesday, the US Federal Open Market Committee (FOMC) kept the federal funds rate unchanged at the 46-year low of 1 per cent. However, the Fed added that the "policy accommodation can be removed at a pace that is likely to be measured", signaling a potential rise in interest rate in the upcoming meeting. The FOMC next meets on June-end. Since the rate hike was ruled out for now, Indian markets cheered.

The market sentiment was further buoyed by the exit poll predictions that there is a greater chance of the NDA government at the centre. These predictions were declared by various TV news channels after third phase of polling ended on April 5. The yield on the 10-year benchmark fell to 5.10 per cent on Thursday. Following this bullish sentiment and ample liquidity, the week's twin bond auction got good response in the market and both were oversubscribed. On Thursday, RBI auctioned a 24-year bond for Rs 3,000 crore and a 12-year floating rate bond for Rs 6,000 crore.

Except for the auction day (Thursday), the liquidity in the market remained at the higher level over the week. This was amply reflected in the daily average subscription to RBI's 7-day repo of Rs 17,646 crore. And the total outstanding at the RBI repo window (both 7-day and 14-day repo combined) stood at a high of Rs 76,100 crore on Friday. The call rate too remained in the lower band of 4.00-4.25 per cent.

The shock came in the late hours on Thursday, when the Bank of England raised its key interest rate for the third time since November 2003 to 4.25 per cent. The rate hike in global markets may affect the foreign capital inflows in India, which has been the key factor for the rupee appreciation and the burgeoning domestic forex reserve. In the week ended April 30, India's forex reserves rose to $118.49 billion from $117.88 billion in the previous week.

The rupee, however, turned weaker for the fourth straight week. This week, the rupee lost 17 paise to close at Rs 44.68/$. Initially, it fell to Rs 44.68/$ due to the global appreciation of dollar ahead of the US Fed meeting. But as the US Fed didn't change the interest rate, the rupee made some gains.

Though inflation fell by 14 basis points to 4.26 per cent for the week ended April 24, it failed to provide any comfort to the Indian bond market due to the expected rise in domestic oil prices. Globally, the Brent crude has touched a 13-year high of $37.05 per barrel by Thursday, following some violence in Saudi Arabia last week.

Outlook
In the coming week, there is only one auction of Rs 1,000 crore 365-day Treasury bill, which is expected to sail through comfortably following ample liquidity in the market. The real worry will be the movement in international oil prices. Any further rise from here could have a cascading effect on domestic oil prices, which may lead to rise in domestic inflation. A high inflation would then put more pressure on RBI to raise interest rates, thus affecting bond investors.