As the market progressively acclimatised itself with Liquidity Adjustment Facility, the volatility in the call money market declined compared to volatility witnessed when LAF was introduced (probably the feedback loop between call rates and reverse-repo rates has lost some strength!)

With the softening of call rates and with no auction announcement, market sentiment improved and gilts at the medium end rallied by 20 paise. There was another 20 paise rally post-EPF rate cut, which was probably sentiment-based only.

The recently re-issued 11.90 per cent 2007 security, which had fallen to Rs 105.25 on June 8, gained consistently to touch Rs 106.15. Call rates have come down to 9 per cent at the start of the reporting fortnight and are likely to ease further till the next auction.Liquidity is likely to ease in the current week on account of inflows from coupons and redemptions in excess of Rs 1,300 crore. However, as Tier-I refinance stands almost fully utilised and with borrowing programme expected to gather pace, call rates are unlikely to drop significantly for quite some time.

Auction on the cards?
Though liquidity position is likely to improve on account of above-mentioned inflows, securities issuances are likely to mop up any excess liquidity and yields are not expected to fall significantly. The Ways and Means advances figure for the week ending June 23 stood at Rs 3,489 crore. With about Rs 4,000 crore of salary outflows at the start of the month and Rs 2,000 crore on account of coupons and redemptions, pressure on WMA will be considerably higher for the week ending July 7.

Moreover, with about Rs 80,000 crore of the budgeted borrowing programme still left, the pace of auctions is expected to pick up whenever call rates ease significantly. As the economy shows further signs of recovery as indicated by the GDP figures for the last quarter of 1999-2000 and IIP figures for April, non-food credit demand from corporates is expected to gather steam at the onset of the busy credit season. Assuming that 80 per cent of the budgeted borrowing programme is completed by the end of October, with just 32 per cent of the programme completed till date, around Rs 14,000 crore of issuances per month are necessitated till October.

As July happens to be the month with maximum inflows, around Rs 17,000-Rs 20,000 crore of issuances during the month could be expected.

An any excess liquidity is likely to mopped up by the sovereign borrowing programme, we don't foresee significant drop in yields and would like to continue with our defensive portfolio - concentrated in low duration, with a change to take advantage of the barbell window. Barbell window open in 1,2,4-year securities . The yield differential between the 11.75 per cent 2001 and 11.15 per cent 2002 securities is 16 basis points, while the differential between 11.15 per cent 2002 and 12.50 per cent 2004 is 31 basis points.

A barbell strategy of replacing the 11.15 per cent 2002 security with a portfolio of 11.75 per cent 2001 and 12.50 per cent 2004 securities provides a yield pick up of about 4.50 basis points while keeping the portfolio modified duration neutral. With all the three securities being sufficiently liquid, this strategy can be successfully carried out.

( For week begining July 3, 2000)