Gilts wary of inflation

Auction looms

Liquidity will be the crucial factor this week, as far as monetary management to check inflation is concerned. The inflation hit a two-year high of 6.58 per cent for the week ended January 27 as against the RBI's annual forecast of 5-5.5 per cent.

Forex inflows, mostly corporate proceeds of overseas borrowings, are perceived to be main source of liquidity.

Dealers are of the view that if the surplus with the market crosses by Rs 10,000 crore, the RBI may consider some monetary management, like increasing notified amount of the bills under the MSS. However, this may not happen this week.

If the RBI did not intervene, liquidity will improve. Otherwise, there could be a squeze after the Rs 9,000 crore auction outflow, said dealers.

Call rates To rule around 6-6.5%

Rates in the interbank call money market are likely to rule around 6-6.5 per cent as liquidity has eased. However, after the outflow towards the g-sec auction, call rates may harden, for inadequate inflows or aggressive absorption by the central bank.

This, in turn, will be contingent upon forex inflows "� mostly direct flows rather than portfolio investment "� into the market. Direct inflows are long term, while portfolio investment are mostly short term.

Treasury bills Cut-off yields to moderate

The RBI will issue 91-day and 364-day t-bills for auction to raise Rs 4,000 crore. With improved liquidity, cut-off yields on t-bills are expected to moderate from the earlier weeks' highs.

However, the RBI's intervention to tackle inflation may make the market bearish resulting in firm yields. This could also be seen as a rise in the amount of t-bills to be auctioned for mopping up excess liquidity. The secondary market may see demand from banks, for investments and building up SLR portfolio.

Government securities May remain jittery

The gilt market may remain jittery. While liquidity has waned, the market has turned wary of the rising inflation. While raising CRR will be too harsh, an increased amount for t-bills or even dated securities is expected as part of market stabilisation scheme, for sterilisation.

Sterilisation curbs excess liquidity and controls its effect on money supply. The RBI may watch the liquidity situation for a week or so before opting for monetary tools.

Since forex inflows are direct inflows, the market is not clear about how sustainable it will be. Moreover, there were outflows of around Rs 9,000 crore towards gilt auction last week.

In this backdrop, the yield on the 10-year paper is likely to rule in the 7.75-7.85 per cent range.

Corporate bonds Eyes on the Budget

The fourth quarter policy review did not help the corporate bonds market much. While issuers were awaiting cues on the interest rate front, the rates shot up following the repo rate hike. Then the inflation concern marred any hopes of moderation of rates.

Some mega issuers including SBI opted for external commercial borrowings, putting bond issues in abeyance.

The issuers, however, think the Budget may offer incentives for the corporate bond mart. Dealers said the bond market saw some investments from custodian banks on behalf of their FII clients. Power Finance Corporation is garnering around Rs 200 crore through a 5-year bond. Rupee Liquidity flow crucial

The spot rupee is well poised in a band of Rs 44-44.25 to a dollar. The market is expecting a robust supply of foreign exchange. To tame inflation, the RBI is intervening aggressively in the forex market.

This was expected to continue, albeit the rupee appreciation that might be allowed so as to keep the currency in a preferred band of 44-44.50 to a dollar, said a dealer. Globally, the dollar is likely to be bullish as the market is expecting favourable data on US retail sales, capital inflows and trade balance.