There was little action in the bond markets during the week ended December 16, 2005. The yields remained largely range-bound and the volumes were thin. The yield on the benchmark 7.38 per cent GOI 2015 bond moved up by just one basis point during the week but fell back by the end of the week to close unchanged at 7.10 per cent. Among the major developments during the week, the Federal Reserve hiked the Fed rate by another 25 basis points to 4.25 per cent.
Bond markets started off on a weak note as the traders preferred to stay on the sidelines ahead of the FOMC meet to decide upon the Fed rate. As a result, the trading volumes fell drastically. A robust 8.5 per cent growth in the industrial output during October 2005 also raised concerns of increase in the inflation and interest rates in times to come. The Fed rate hike was largely in line with the market expectations. However, expectations that the Federal Reserve may bring an end to the successive hikes in the Fed rate comforted the market participants. But the bonds were kept from any significant gains by the tightening liquidity on the back of quarterly tax outflows. Moreover, the RBI Governor's comments indicating a further tightening of the liquidity position added to the worries. RBI Governor Y.V. Reddy said that liquidity may tighten further owing to the redemption of India Millennium Deposits.
Inflation remained benign. For the week ended December 3, 2005, inflation stood at 4.55 per cent, almost unchanged from previous week's 4.54 per cent. This was lower than the market expectations. Even though food articles became costlier, a drop in the prices of non-food items kept the inflation from rising sharply.
The rupee made significant gains over the week to reach its one-and-a-half month high by the end of the week. Strong FII inflows, coupled with the US dollar's weakness against the major currencies helped the Indian currency gather strength. The rupee ended stronger on each of the trading days during the week to cross the psychologically important 45.5 per US dollar mark.
Call rates kept rising throughout the week, amid tight liquidity conditions. By the end of the week, they were at 6.15-6.25 per cent, much higher than previous week's close of 5.30-5.40 per cent.
Liquidity can pose a concern for the market participants in the coming week, particularly in the wake of comments made by the RBI Governor. Traders would anxiously observe the combined effect of tax outflows and the redemption India Millennium Deposits on the liquidity in the system. Therefore, we might see a cautious start to the next week.