Gilts take fright at rising inflation, Fed rate hike fears

The rising rate of inflation and apprehensions of a 25 basis points hike in the US Federal Reserve rate played havoc in the government securities market today. Prices of long-term paper fell by about Rs 2.50. At the medium-term, priced dipped by almost Re 1.

The Federal Open Market Committee (FOMC) is meeting tomorrow and is expected to announce an increase in the base rate. The wholesale price index -based inflation rate has risen to 7.51 per cent.

The yield on the ten-year benchmark 7.37 per cent 2014 paper closed at a high of 6.50 per cent, versus 6.29 per cent last week.

At its government paper auction, the Reserve Bank of India signalled its comfort with the market related rates. It auctioned the floating rate bond 2015 at a spread of 50 basis points to the yield on 364-day treasury bills. With this cut off, the effective rate of a one-year bond works out to 5.12 per cent. At present, the yield on a 364-day T-bill is 4.62 per cent.

The higher spread shocked the market which had been expecting a spread of a maximum of 33 basis points.

Bond dealers said the cut off yield hints at a tightening of rates in the short end of the maturity. Had that not been the case, the RBI could have rejected the bids at the higher end and taken the devolvement on its own. The 30-year stock, however, was auctioned at a cut off rate of 7.12 per cent. This is in line with market expectations.

Dealers are confused by the conflicting signals from the government and the RBI. While the RBI seems to be comfortable with the rising interest rates, the government has slashed the employee provident funds' rate by 50 basis points to 8.5 per cent.