Rupee gains on hopes of US lifting sanctions: The US congress has given President Clinton flexibility in revoking the economic sanctions against India and Pakistan. With hopes of US lifting sanctions improving, the rupee appreciated to 42.45 against the dollar. This year's forex dealers' annual conference has been a non-event unlike last year (Remember Dr Reddy's statements at Goa at last year's annual meet which triggered the first sharp drop in the rupee?). The rupee is likely to trade between 42.45 and 42.55 during next week.The big event in international markets was the easing of Fed rate by 25 basis points. The US treasury bonds have staged another sharp rally, and the 30-year long-bond wasquoted at 4.88 per cent yields, the first time ever below 5 per cent.

RBI moves to activate T-bills market: The RBI has hiked the cut-offs of both 14-day and 91-day treasury bills to secondary market levels. The 14-day cut-off was fixed at 8.89 per cent and the 91-day cut at 9.99 per cent yields. The sharp hike was a surprise to the market as indicated by the weighted average yields of 8.63 per cent and 9.57 per cent, respectively.

The higher yields are expected to increase participation in the treasury bill markets. RBI's acceptance to align the cut-off in the 364-day treasury bills would also be higher this week - 10.40 per cent to 10.50 per cent levels from the last 9.60 per cent cut-off.The open market operations (OMO) list has the December 12 treasury bill at 9.66 per cent yield and the December 26 treasury bill at 9.86 per cent yield. This would place at floor on secondary market yields.

Two-year security cut-off at 11.40 per cent: The two-year security auction did not attract asenthusiastic a response as anticipated. The cut-off was at 11.40 per cent (with 7 per cent of the issue devolving on primary dealers), and the secondary yield curve has shifted up at the shorter-end following this auction. State development loan announced: The second tranche of the State Development Loan (SDL) will be issued on October 12 and the coupon has been fixed at 112.50 per cent.

The notified amount is Rs 3,100.28 crore and the good yield is likely to attract strong response. Yields likely to tighten further: The yield curve has flattened further with the yield differential between a two-year security and ten-year security at 87 basis points. With the coupon for the SDL issue fixed 25 basis points above the last 10-year government of India security cut-off and 23 basis points over its secondary market yields, there would be an upward pressure on the yield curve at the long end. However, the volumes at the long end would continue to be thin. With the state loan issue on the October 12, we do notexpect another auction during the next fortnight. Yields at the short-end are also likely to tighten further, after the hike in treasury bill cut-offs. The increase in the two-year yields is likely to spill over to the medium segment of the yield curve. The yield curve next week is expected to be: 91 days: 10 per cent, one year: 10.5 per cent, two year: 11.4 per cent, three year: 11.6 per cent, five year: 11.85 per cent and ten year: 12.3 per cent. We advise investors to take a defensive stance and concentrate on the soft end. Corporate paper: Yields on CPs and CDs are likely to tighten by at least 25 basis points following the tightening in treasury bill yields. Three month P1+ rated CPs traded near 11.25 per cent last week and are likely to quote above 11.50 per cent.

However, with call rates remaining near 8 per cent, one month CPs are likely to stay near the current 10.5 per cent levels. With the primary market pressure easing following the half-year end, secondary market yields are expected to easefor financial institution paper.

(For the week ending October 8,1998)