The bond market remained nervous this week as the Bank of England (BoE) raised rates by 25 basis points (bps) to 4.5 per cent on Thursday, its fourth hike since November. Moreover, Alan Greenspan's recent comment to prepare for a sharper rise in US interest rates if inflation remains high, added salt to the market's injury. The only relief was the lower than expected rise in inflation. Consequently, the yield on the 10-year benchmark (GOI 2014, 7.37%) closed at 5.32 per cent - up 4 bps over the week.
In the corporate bond market, the yield on the 5-year bond rose 8 bps over the week to close at 6.04 per cent. On the other hand, the yield on the 5-year government bond (GOI 2009, 11.99%), closed at 5.05 per cent, up 5 basis points from the previous week. The spread between 5-year corporate bond and government security remained constant at 98 basis points on Friday.
Though the rise in yield was across the board, the yield on shorter maturity bonds rose more than the medium-term counterpart. Thus, the spread between 5-year and 10-year government security narrowed from 32 bps last week to 26 bps this week. Also, the spread between 5-year government bond and 15-year bond contracted from 88 bps last Friday to 86 bps this Friday. Consequently, the yield curve flattened a bit this week compared to previous week.
Inflation based on Wholesale Price Index remained high for the second successive week. It rose to 5.03 per cent in the week ended May 29, compared with 5.02 per cent a week before. This was well below the market estimate of 5.28 per cent but failed to buoy market sentiment as the Bank of England's rate hike overshadowed this. International oil price remained volatile during the week amidst demands from G-7 countries to OPEC to step up production. However, the price of Brent crude was $35.74 per barrel on Friday, down from the previous week's price of $37.16 a barrel, after OPEC decided to hike output.
On Wednesday, RBI auctioned Rs 1,500 crore 91-day treasury bills and Rs 1,000 crore 364-day treasury bills under the market stabilisation scheme. This auction had a negative impact on the liquidity in the market. This was widely reflected in the 16 per cent fall in the daily average subscription to RBI's 7-day repos over the week. The total outstanding amount at the RBI window (both 7-and 14-day repo combined) also slipped from Rs 67,445 crore last Friday to Rs 57,020 crore this Friday. However, the call rate hovered between 4.25-4.50 per cent on Friday.
In the currency market, the rupee lost 4 paise against the US dollar last week to close at Rs 45.16 on Friday. However, the dollar touched Rs 44.98 on Wednesday for the first time in more than a month, buoyed by renewed foreign fund investments into local shares. But demand from a large state-run oil firm combined with the dollar's strength overseas pushed the rupee down. India's foreign exchange reserves fell to $119.68 billion on June 4 from $119.82 billion a week earlier due to a drop in the value of gold assets.
The constant decline in trading volume for the past six weeks came to a halt as the average volume in the wholesale debt market rose by 17 per cent this week to Rs 3,517 crore, thereby reversing the trend.
Outlook
In the coming week, there will be a twin auction of Rs 9,000 crore. A consistent high inflation and the rise in global interest rate is worrying domestic investors. The market is looking forward to the June-end US Fed meeting. Till then, in the absence of any major negatives, bond yields should move in a narrow band.
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