Inflationary trend to set the tone for gilts
The movement of government securities will depend on the movement of headline inflation rate (now at 2.85 per cent), which has been northward bound since the last eight weeks.
If it edges up further, there will be a dampening effect on the gilts market. Otherwise, there will be a mild 50-60 paise, liquidity-driven rally in the medium-tenor papers.
There will not be any pressure at the short-end of the yield curve. At the long-end, however, the curve could steepen, as back-to-back auctions of long-dated papers (of 15 and 20 years tenor) are scheduled for the last week of this month and the first week of next month.
Meanwhile, the sentiment in the market is expected to be flat-to-weak, as the Reserve Bank of India (RBI) will suck out Rs 8,000 crore thorough auctions.
As almost Rs 20,000 crore will be sucked out of the banking system in the coming three weeks through auctions, the central bank is expected to accept bids at the repo window, either partially or totally reject them to ensure that there is enough liquidity remaining in the system.
The fact that the RBI has slackened purchases of US dollars and allowed the rupee to appreciate is also an indicator that it is preparing the ground for the auctions. Further, the banks are having unavailed refinance of around Rs 8,000 crore to fall back in case of a liquidity crunch.
Market players are expected to stay on the sidelines in view of the impending auctions.
The benchmark 7.40 per cent 2012 paper, which was dealt at a yield of 7.18 per cent on Saturday, could test 7.15 per cent, if the sentiment turns bullish. The possibility of this paper piercing the 7.15 per cent is remote.
The proposed on-tap sale state development loans by all the 28 states is expected to sail through. The RBI is expecting to mobilise about Rs 4,478 crore through the issue. This is the second tranche of the market borrowings programme for the state governments in the current fiscal.
The differential between the state government loans and the like-tenor government securities has widened to almost 60 basis points indicating weak fiscal position of many of the states. A year ago, this spread was 25 to 30 basis points.
