Thanks to the aggressive RBI intervention in the forex market and some MSS cancellations, even the liquidity situation has improved quite dramatically.

Pranav Thakur

THE last fortnight saw two important events, the yuan revaluation and the first review of this year's monetary policy.

China revalued its currency by two per cent and left a theoretical possibility of another one per cent revaluation every month.

The market had been talking about a possible revaluation for quite some time; few however had expected it to happen now.

The rupee gained almost one per cent in no time but we saw it close back down at the same level on the back of some aggressive central bank intervention.

The RBI had not intervened in the foreign currency market at all in the first three months of this financial year. Hence, such aggressive intervention did surprise some.

However, as the rupee went back to the 43.50 levels, we saw some forward selling interest. The currency swap curve fell by almost twenty basis points from the day of the revaluation.

No rate hike in the monetary policy review may not have aided the fall, but has definitely taken out the possibility of a sharp reversal.

With the possibility of further appreciation of the yuan, the rupee does not look like loosing ground atleast in the near future.

Any weakness in the currency will surely be used as an opportunity to sell the dollar against it, which in turn should keep a lid on the forward curve.

Against popular expectation, the central bank chose to keep the key rates unchanged for now.

In its own words, "the considerations in favour of status quo are evenly matched by those for change in stance, but the balance of convenience at this juncture lies in continuing with status quo while monitoring the unfolding constellation of uncertainties, especially in the global arena".

The absence of a rate hike in the policy caused a sharp rally in bonds.

The whole bond curve came down by 20 basis points to 25 basis points on the back of this news. Even the OIS (Overnight Index Swaps) curve came down by almost 20 basis points right through.

The 10-year sovereign bond yield had stayed in the 6.75-7 per cent range for the whole of June.

It broke the range on the upside primarily on account of expectations of a rate hike in the July 26 review, some bunched up supply and dwindling liquidity.

With the fear of a hike out of the way, sell offs in the market should be shallow.

Thanks to the aggressive RBI intervention in the forex market and some MSS cancellations, even the liquidity situation has improved quite dramatically.

With the maturity of Rs 20,000 crore of 6.18 per cent GoI 2005 on September 3 under the MSS programme and no plans on the part of the RBI to roll it over, the system is expected to be again flushed with money.

In the absence of any explicit measure by the central bank to reign in liquidity, it looks like liquidity will not be a problem for a long time.

Even the problem of too much supply of bonds seems to be not much of a concern for now.

Over the next two months, the government is slated to issue Rs 24,000 crore worth of bonds, out of which Rs 9,000 crore will be in the 20-year plus bucket.

Hopefully, the largest insurer in the country will have appetite for these.

We have Rs 18,500 crore worth of bond maturities in the same period to take care of the rest.

Add to that the possibility of a floater at some point in time going ahead and the overall picture does not look so grim.

With all the three factors that had caused the range to break, having abated, it looks like we shall be settling back in the 6.75-7 per cent range for 10-year bonds.

US rates and crude prices continue to be sources of concern though.

With the supply overhang looking like reducing going ahead, the bond swap position has started making sense now.

Buying 7.27 per cent GoI 2013 and paying the 5 year OIS against that might make one some money from here.

The 5 cross 8 govy curve at almost 9 basis points a year is as steep as it can be and should only compress going ahead and that is why I suggest buying it instead of the standard 7.55 per cent 2010 paper.

At the same time, we could see the one cross five-year currency swap curve steepen from here.

There seems to be little receiving interest in the five years whereas all forward sales and option trades should see receiving come in the short end.

(The author is senior trader, Interest Rates at HSBC Mumbai. The views expressed herein are his own and not necessarily those of his employer.)

(This article was published in the Business Line print edition dated August 1, 2005)
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