Expectations of truce in the Middle East increased, mollifying sentiment in international markets. With a hike of 5 lakh bpd output by OPEC this week, helped ease crude prices - the benchmark IPE Brent crude oil future traded below $31.00/bbl for most of the week. Weaker US economic data triggered a realignment in currency markets around the world. Currencies, notably the euro and the yen, recouped some of their recent losses against the US dollar.

Gilts surge as rupee strengthens
The successful defence of the rupee by state-run banks infused confidence in the gilts market. The markets rallied strongly throughout the week, with the 11.40 per cent 2008 security registering a large gain of Rs 1.15 over the week from Rs 99.75 on Monday (11.44 per cent YTM) to Rs 100.90 on Saturday (11.22 per cent).

RBI has announced re-issue of Rs 3,000 crore of the 11.99 per cent 2009 security through a price-based auction on November 6. The auction announcement did not surprise market participants and failed to impact bond prices. Coming against the backdrop of bullish sentiment and comfortable liquidity, and with a relatively small notified amount of Rs 3,000 crore, the auction is likely to sail through. That the 8-10 year residual maturity segment of the yield curve has been at the forefront of action in recent times also augurs well for the auction.

Call rates move up to 10%; repos dwindle
On the back of comfortable liquidity, call money rates hovered around 8 percent-8.50 percent range for most of the week. However, as demand for funds increased and large lenders opted out, call rates spiked to 10 per cent-10.25 per cent on Friday. A few deals were reported at 11.00 per cent as well. Call money is currently trading at 9.75 per cent-10.00 per cent.

The repo auctions finally ran out of subscriptions this week. On both Thursday and Friday, RBI did not receive any bids for the regular or special repo auctions. The amount outstanding in repos has thus dropped to zero for the first time since the introduction of the special repo auctions in July. With RBI displaying increased confidence in tackling currency volatility through conventional means and call rates ruling high, we do not expect repo auctions to garner significant interest.

There are around Rs 2,000 crore of available funds by way of unavailed tier-I refinance and approximately Rs 800 crore of coupon and redemption inflows this week. However, these are counter-balanced by the auction amount of Rs 3,000 crore. With the liquidity position unlikely to change significantly, call money rates are expected to settle around 9 per cent levels this week.

Another auction likely
Ways and Means Advances (WMA) to the government for the week ending October 27 stood at Rs 3,822 crore. There are outflows of around Rs 1,600 crore on account of coupon and redemption payments over the period October 28- November 10 (net of T-Bills). Salary payments of approximately Rs 4,500 crore were also made last week. Adjusting for these and for the Rs 3,000 crore re-issue on November 6, the WMA balance for the week ending November 10 is expected around Rs 7,000 crore. This is significantly higher than the trigger point of Rs 5,250 crore for fresh market issuances.

Therefore, the demand for market funds from the government is unlikely to abate and another issuance of Rs 3,000-4,000 crore is likely.

Over the course of the strong rally last week, the yield curve underwent a parallel downward shift of 14-20 basis points. However, the yield curve continues to be steep - more than 65 basis points separate the four and eight-year yields and another 33 basis points separate the eight-and 12-year yields. The upside potential in the event of a correction at the long-end is thus significant. With bullish sentiment going into the re-issue of the 11.99 per cent 2009 security, we increase our positions at the long-end to capture any upside.