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B. Venkatesh

THE RBI finally resorted to OMOs (open market operations) to drain the excess liquidity from the system. On August 14, the RBI took Rs 11,470 crore out of system. Yield on the 6.35 per cent 2020 bond, which attracted bids less than the notified amount, closed 7 bps lower than the cut-off yield at the OMO.

Week-on-week, the term structure remained tight, with the front-end steepening marginally by 3 to 8 bps. Going forward, bonds are likely to continue trading in a range, because of conflicting factors at force.

The positive factor is that the RBI is unlikely to hold primary auctions till the next first week of September. This will prevent any supply overhang in the market, a factor that will prompt dealers to keep bonds bid. The reason is that liquidity in the system is comfortable, the recent OMO notwithstanding. It is evident from the fact that the RBI received Rs 14,065 crore under the 4-day repo on August 14.

The factor acting against the market is the OMOs. The OMOs held on August 14 has clearly sent a signal that the RBI may not hesitate to conduct more such auctions if bonds remain overly biddish.

Dealers may ALSO be wary of the systemic risk. With the front-end of the yield curve easing marginally, aggressive dealers may be prompted to engage in carry trade, what with overnight rates remaining stable. But that could only increase the risk on the trading book. The risk appears very high, especially where the portfolio is loaded with long-ends. The reason is the yield curve has become so concave that the long-term bonds hardly offer any convexity advantage; the long-term spread is currently 62 bps.

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