Short-term rate signals

A good way to look at forecasts on the interest rate front is to see what is happening to yield curves. Yield curves plot the spreads between government bonds of short maturity and those of longer term maturities. In the last three months, a combination of tightening liquidity and Reserve Bank rate hikes has reduced spreads between five-year government paper and 10-year bonds to about 30 basis points from 45 basis points earlier. This means that the yield curve has flattened in the last quarter. When yields at the short end go up sharply it is also indicative of a higher interest regime in the short run. Yields on long-term government bonds, too, have risen in recent times, but not as sharply. The government announcement of a fresh, unscheduled Rs 15,000 crore borrowing programme in March has not helped prices. On Monday, government bonds fell for the fifth consecutive day, pushing yields further up. But, this is expected to be a short affair. By April the yield curve is expected to show signs of steepening with enough amount of liquidity being available. This is because government spending goes up tremendously in March and this infuses liquidity. That apart, the RBI, too, has been buying dollars from the market and ensuring that the rupee does not gain too much against the dollar. Buying up dollars also infuses liquidity. Analysts feel that by April-May, call money rates will quote below the reverse repo rate of 5.5% and yield curves will start showing a sharper upward slope. A dampener though may be the expectation of another rate hike announcement by the RBI in the next fiscal, keeping in mind the fact that both the US Fed and the European Central Bank, not to speak of the Bank of Japan, are signalling tighter money.
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