Low inflation boosts gilts, rupee looks up

RECAP

The decline in the inflation rate to 7.20 per cent for the week ended October 1 charged up government security prices and the foreign exchange market last week.

However, while the rally in the dollar-rupee exchange rate continued with the global depreciation of dollar on the back of a fall in the US job data, lack of positive triggers and buying demand from nationalised banks hit gilt prices.

The cut-off yield of 6.98 per cent announced at the auction of the 7.38 per cent 2015 gilt as part of the government's borrowing programme has sent signals of a rise in interest rates in the short-term.

According to market players, the cut-off yield has indicated that the RBI is comfortable with rising yields as the entire auction sailed through despite the yield being higher by 39 basis points.

The reissued 11-year gilt paper closed last week at 6.59 per cent. This, in turn, resulted in an upward realignment of interest rates across maturities, said dealers.

While prices in long-end papers fell by almost Rs 3, medium-term gilts witnessed a Rs 1.50 dip in prices. The yield on the 10-year benchmark paper 7.37 per cent 2014 closed at a two-and-a half year high of 6.92 per cent.

The market sentiment received a new lease of life when the government stated that interest rate hikes will retard the GDP growth. Some market players are of the view that interest rates in the near-term will not be tinkered with.

This made a section of the market think that the coming days will see value-based buying of gilts which are currently available at low prices.

A rise in interest rates has been discounted in the foreign exchange market as well.

The rise in the interest rate differential between the domestic and US interest rates resulted in a sharp rise in forward premiums. The six-month and one-year forward dollar premiums moved up to 2.66 per cent and 2.25 per cent, respectively, last week.

However, the funds parked at the repo auctions came down to Rs 9,000 crore during the week and the interbank call rates softened to 4.4-4.5 per cent.

Call rates hardened to 4.5-4.6 per cent last seek.The spot rupee witnessed a bullish sentiment which resulted in the appreciation of the rupee. However, the movement remained in the three-four paise range with forex inflows matching the demand in the system.

Foreign exchange market dealers also added that besides customer and interbank demand for dollars, the sentiment is adding to the bearishness in the market.

This again is being fuelled by the rising interest rate scenario in the Indian market as well as the spiraling oil prices.