Yield on 10-year government securities rose 4 basis points after falling to its lowest level since May 2004.
According to data on the Clearing Corporation of India website, yield on 8.24 per cent paper due in April 2018 fell to a low of 5.20 per cent during the day as a further drop in inflation based on wholesale price index raised hopes of a reduction in interest rates by the Reserve Bank of India.
But traders said that profit booking and the extent of rate cuts that RBI may undertake erased the gains. At close the yield was 5.29 per cent.
Banks and securities companies may have scaled back purchases of the notes after yields dropped 1.82 percentage points in December, the biggest monthly decline in at least a decade.
This is the first time in four days that the yield on 10-year bonds has dropped.
With interest rates falling, yield on 10-year government security dropped 254 basis points in 2008, the steepest decline since 2001.
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Falling yields augur well for banks as they can hope to make higher treasury gains and offset some of the losses due to higher delinquency
Trading in interest-rate swaps indicated traders increased bets for further reductions in borrowing costs. The cost of five-year swaps, or derivative contracts used to guard against rate fluctuations, slid to the lowest level since October 2003.
The rate, a fixed payment made to receive floating rates, fell to 4.55 percent from 4.615 percent yesterday, according to data compiled by Bloomberg. It fell 2.42 percentage points in 2008, the most in six years.
The rupee also erased early gains due to demand from petroleum refiners in the wake of higher crude oil prices.
The rupee gained as much as 0.8 percent to 48.375 per dollar, before closing at 48.765. The rupee closed at 48.775 yesterday, losing nearly 24 per cent against the US currency in 2008.
Though the rupee strengthened in early trade on slightly buoyant sentiments in the equity markets. The Bombay Stock Exchange Sensex rose over 200 points on the first day of trade in 2009.
This is the first time in three days that the rupee has strengthened. Global investors bought a net $30.8 million of local shares on Dec. 30, following five days of net sales, according to the latest data provided by the Securities & Exchange Board of India. They sold a record $13.3 billion last year as the Bombay Stock Exchange Sensitive Index, or Sensex, tumbled 52 percent, the biggest drop since at least 1979.
Trading in the currency was, however, was less than normal on the first day of the year, with most Asian markets closed.
Non-deliverable forward contracts indicate traders are betting the rupee will weaken to 49.20 in three months, Bloomberg data show.
Forwards are agreements in which assets are bought and sold at current prices for future delivery.
Indian rupee forwards traded overseas are non-deliverable, meaning they are settled in dollars rather than the local currency.
In the futures market, the indications are that the rupee will weaken marginally in the months ahead though dealers are predicting an appreciation towards the end of 2009.