What a week it was. The yield on the 10-year benchmark bond (GOI 2014, 7.37%) touched a 13-month high of 5.89 per cent before closing at 5.82 per cent on Friday – a rise of nearly 38 basis points over the week. It all started when RBI Governor YV Reddy said on Monday that in case global interest rates tighten at a much faster pace, the soft monetary policy stance might be revised. And as if that was not enough, a sharp rise in inflation further added salt to the injured market.
The RBI governor's comment came at a time when the market sentiment was already weighted down by a higher than expected rise in inflation last week and the increasing hope of US rate hike. The US Federal Reserve is expected to announce a hike in the key funds rate in the next week's meeting on Wednesday. The market has already discounted a 25 basis points rate hike. The US key fund's rate is currently at a 43-year low of 1 per cent.
The biggest jolt for the bond market came on Friday, when inflation surged to nearly four-month high of 5.89 per cent in the week ended June 12, 2004 from 5.55 per cent a week ago. This created panic-like situation in the market and the yield on the 10-year benchmark touched 5.89 per cent in intra-day trades. But soon, India's Chief Economic Advisor, Ashok Lahiri came to the rescue. He said that the government is committed to price stability and he did not see rising inflation impacting domestic interest rates. Thus, the yield calmed down a bit to close at 5.82 per cent on Friday.
In the mid-week, RBI also tried to control the rising yield by rejecting some of the bids at the 364-day Treasury bill auction under the market stabilisation scheme (MSS). In the coming week, the government will announce the new calendar for issue of bonds and T-bills under the MSS for the July-September quarter. In the first quarter of 2004-05, the size of MSS was Rs 35,500 crore out of the total Rs 60,000 crore set aside for the full fiscal. However, this size is expected to go up following excess liquidity in the system.
Despite all the hue and cry over rate hike and rising inflation, one thing that has remained comfortable is the liquidity in the system. The 7-day repo outstanding at the RBI window has been over Rs 55,000 crore in the past three months. Thus the call rate remained in the 4.25-4.5 per cent band over the week.
The lack of excitement among the bond investors was amply reflected in the low daily average trading volume of Rs 3,500 crore this week. The trading volume has, in fact, remained at this level in the past two months. In April, the daily average was over Rs 6,000 crore, which fell to 3,800 crore in May and 3,500 crore in June.
The rupee continued to slide against the US dollar for the third consecutive week to close at Rs 45.83/$ -- down 16 paise. In fact, on Tuesday, the domestic currency touched an 11-month low of Rs 46.25/$ due to a rise in the dollar as the US economy recovers and the rate hike expectation. That apart, the higher than expected inflation has raised hopes of a rate hike in India. As a result, the 3-month dollar forward premium rose to 2.1 per cent on Friday compared to 0.82 per cent in the previous week. The 6-month dollar forward premium surged to 1.45 per cent this week from 0.54 per cent last week.
Outlook
In the coming week, all eyes will be set on the US Federal Reserve's Wednesday meeting in which the faith of the US interest rate will be decided. A hike of 25 basis point is expected. The government will also announce the schedule for issuing bonds under the market stabilisation scheme for July-September quarter. The inflation number will be the closely watched market indicator. All these developments will set the tone for the Indian bond market in the coming week.
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