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B. Venkatesh

THE bond market was wobbly intra-week. The 10-year yield rose to 5.20 per cent due to tight liquidity on account of OMO, but later fell to close at 5.12 per cent. Going forward, bonds are likely to remain bid, with the November 3 credit policy setting the tone for the week.

The system is flush with liquidity, due to further inflows from RBI dollar buying. This was evident on Friday when overnight rates fell below the repo rate. The Central bank may not sterilise the reserve money immediately through its OMOs. The higher liquidity could keep bonds bid.

The market appears to have factored a possible rate cut by the RBI in the forthcoming credit policy. Should the rate cut materialise, bond dealers may keep bonds bid, knowing that the Central bank is pursuing a soft interest rate bias.

Of course, the shape of the yield curve and inflation numbers will certainly weigh on the speed and the magnitude of the rally. At present, the long-term spread is 73 bps, 2 bps lower than the previous week; short-term spread increased 2 bps to 51 bps. This suggests that the market is rather apprehensive of large non-parallel shifts in the yield curve, unless of course the RBI makes any policy level changes that can affect the long-term and short-tem rates. That is the event risk that the market faces in early trades on Monday.

Then, there is the inflation number. Inflation rose 7 bps to 5.01 per cent for the week ended October 18. This may lead to higher inflation expectations, diffusing any sharp bond rally. Of course, bond dealers may well ignore inflation if RBI persists with the soft interest bias in its credit policy. Bond funds that have exposure to the long-end may see better returns that ones with short- and-medium tenors.

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