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Fixed income markets witnessed a fall in yields across the curve in the past week, comforted by announcement of an open market operations by RBI and improved liquidity. As expected, yield curve steepened further with short end of the curve drawing strong demand and with increased trader’s interest at long end. Global markets generally remained range bound in the face of a shut-down of US government in expectation of a quick resolution this week. With foreign currency swaps attracting over $5bn, the rupee appreciated for the third straight week, by nearly 2% to 61.44 at close. This further strengthened expectations of reversal of the emergency liquidity tightening measures of July. While three month bank certificates of deposit rates eased 15 bps to 9.50%, anchored by current MSF rate of 9.50%, much stronger drop was witnessed in one year CD where the rates eased by 25 bps to 9.30%. 3-5 years segment also saw yields drop by 20bps, with 5 years government bond yield at 8.62%. Benchmark 10 year government bond yields dropped by 10 bps at 8.61%.
MSF borrowings which stood at Rs 90,000 crore in the previous week eased substantially to Rs 32,000 crore last week. With over Rs 50,000 crore of cash management bills maturing in next two weeks with little chance of fresh issuance and dollar flows picking momentum, expectations are building up of overnight rates reverting to the regular repo rate of 7.50% shortly and will possibly fuel further the rally in short term rates next week as well.
Markets will await developments on negotiations on resolution of the US government shutdown and will keenly watch for signals on increase in debt ceiling for US government. The present belief is that an acceptable solution would be eventually reached, just in time for US to avoid a final default on its debt obligation. Failing which, global markets may suffer a setback severe enough that it may take years to for them to recover. However, if the talks continue to drift on continued stalemate, at some point, markets may lose patience and panic. After the positive momentum of the last week, this may set the stage for a correction in bond prices. With RBI standing firm on providing adequate liquidity and conducting OMOs, such correction would be a good opportunity to build fresh positions. Markets are thus likely to be range bound with profit booking at higher levels and bargain hunting at lower levels. The two week high-low would continue to be the reference point for capturing this range.
Mahendra Jajoo is Executive Director & CIO-Fixed Income at Pramerica Asset Managers
