A short rally likely

B. Venkatesh

BONDS may witness a short rally in the coming fortnight.

The following are the factors pointing to such a conclusion.

First, the liquidity in the system appears comfortable. Consider this. The Tier I refinance at the bank rate has been drawn only to the extent of Rs 10,507 crore. Further, at the auction for the 364-day Treasury Bills, the Reserve Bank of India (RBI) received bids for Rs 1,325 crore against a notified amount of Rs 500 crore. The ample liquidity may see more money flowing into the bond market, driving up bond prices.

Second, the positive development in the forex market. In this regard, three factors are noteworthy. One, the decision by the OPEC members to step up oil production has driven down international oil prices. Considering that a spike in oil prices was a primary reason for the fall in the rupee, the current oil price decline may be viewed as a positive signal by the market. Two, the reports that the State Bank of India has collected nearly $ 2 billion towards its India Millenium Deposit offer is another positive factor. And three, the fact that the RBI has gradually cut the repo rate to the current level of 8 per cent suggests that the central bank is comfortable with the current rupee levels. The likelihood of a stable rupee may lower demand for dollars meaning banks may have more money to invest in bonds.

But it is not as if the rally will last for long. Capping the rally is the likelihood of a couple of bond auctions in the near-term. The reason? The government's Ways and Means Advance (WMA) has now been reduced from Rs 11,000 crore to Rs 7,000 crore. Not only has the government shot past 75 per cent of WMA limit but also has an overdrawn balance. This and the fact that the government is yet to complete nearly 30 per cent of its borrowings for the current fiscal may necessitate the RBI to hold auctions.

Now, bonds typically fall after an auction announcement. Since there are signals aplenty at this point in time that the RBI will hold a couple of auctions, the market may be wary of driving up bond prices too far. In the light of these factors, a short rally appears to be on the cards.