Bond traders in India were a little bit nervous as yields have stayed firm for almost three weeks in a row amid tight liquidity conditions and external uncertainties.

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Last week opened with a somewhat positive momentum as weekend announcement of two open market operations (OMOs), temporary softening of US Treasury yields on the back of dovish comments from a centrist FOMC member and softer crude prices, provided positive clues to traders. However the mild rally fizzled out as renewed fears of Brexit and its impact on global financial markets, steady firming up of US yields as the week progressed and the results of OMO auctions, which was below expectations, soured trader sentiments.

RBI conducted two OMO auctions on Monday and Tuesday, as system liquidity got tighter and negative. On Monday, against the announced Rs 20,000 cr auction amount, Rs 18,260 cr was offered at expected levels and therefore markets ignored the results. However, the next OMO on Tuesday saw aggressive offering by participants with more than 500 billion rupees on offer against a notified 100 billion. This suggested both tightening liquidity conditions and some amount of desperation to profit-booking. The sentiment was further worsened with a record 201 billion SDL auction in which 19 states issued bonds. The cut off in the 10y segment came with a 45-47 basis spread and dampened sentiments further. The benefits of two OMOs was totally lost from a liquidity perspective with the state loan auction.

With system liquidity teetering and negative in excess of RS 50k crore, any rally is used as an opportunity to sell bonds. Short tenor money market yields are slightly up, however no panic is seen. With RBI announcing regular repo auctions and banks sitting on excess SLR, there is some comfort for money markets. Tighter liquidity conditions may prevail for a few more weeks as the FCNR redemptions are still underway and could exacerbate liquidity tightness during a festival season. Forward Premia has eased significantly helping keep the shorter end of the money market curve soft. To end the week, auctions results on Friday came on expected lines, barring a devolvement in the 2022 paper.

Looking ahead, the first half of November could be more eventful for markets as FOMC meeting and payroll data in the first week could keep the data conscious markets on edge. US Elections the following week, which has already become a single biggest factor for subdued market activity, will be a global event risk to watch out for. With a no-change decision for the November FOMC-sitting a given proposition, odds of a hike in December remain strong.

For domestic markets, while inflation worries are out of radar, one would still look forward for any surprises. System liquidity remaining what it is, prospects of further OMO announcements are strong. The deficit appears to be structural rather than frictional, hence OMOs can address that better. Benchmark 10 year yields should find buying support near 6.95% (corresponding to circa 6.82 in the new paper). Happy Diwali.

The writer is executive director, Lakshmi Vilas Bank