“The market is prepared and the yields are close to the expected peak,” says a bond trader. “Eight per cent is psychological...and that’s where it could go max,” he says about the benchmark 10-year government bond yield.

“At current levels, people have factored in much more than a CRR hike. So when they see that the RBI action is much softer than was expected, big buying will have to come,” says a senior bond dealer with a British bank.

The consensus in the market is that the central bank will raise the cash reserve ratio (CRR) by 50 bps to 5.5 per cent. It is expected to leave the reverse repo and repo rates unchanged at 3.25 per cent and 4.75 per cent, respectively.

With some measures of inflation running into double digits – mainly on account of food prices and primary articles – the central bank is expected to take measures to ensure that inflation doesn’t become generalised amid copious inter-bank liquidity.

Most bond traders say they have drawn the expected trajectory for bond yields for the next three months: The 10-year will briefly touch 8 per cent if the RBI tightens its monetary policy, and it will climb down to current levels by March in the absence of fresh borrowing by the government.

Come April, the yields could start to climb up again if the budget estimate of the government’s market borrowing for 2010-11 (Apr-Mar) matches the Rs 4.51 trillion in the current financial year, dealers say.

Since April 1, the exact 10-year bond yield has swung between a low of 6.05 per cent and a high of 7.71 per cent. Traders say that a 25-50-basis point hike in CRR has been priced in already.

“All possible liquidity draining steps which the RBI may announce on January 29 has been discounted by the market,” according to a dealer with a foreign primary dealership.

In fact, some players are of the view that if the RBI increases only the CRR on January 29, bond yields could fall after a knee-jerk rise. “Basically, there is no need for a rate hike now as the economy is just recovering and a hike will hurt the investment climate,” says G A Tadas, managing director and chief executive officer, IDBI Gilts. “Also, when credit is not picking up despite such low rates, a hike in interest rates will hurt loan growth further.”

Industrial growth in November surged to 11.7 per cent against a market expectation of 10 per cent, from 10.3 per cent in the month before.

A senior treasury official at a large private bank thinks, “More confidence about the sustainability of the economic recovery is needed. I am linking this to the fact that the kind of robust credit numbers which should correspond to such high industrial growth are just not there.”

Absence of supply

Given that the stress is on the need to return to fiscal consolidation, analysts peg a low probability on extra borrowing by the government in 2009-10. Finance Minister Pranab Mukherjee had on December 30 reiterated the need to return to the path of fiscal discipline as “we cannot continue with a high fiscal deficit indefinitely”.

The absence of the expected inflows from the 3G spectrum auction is another reason why we may not see any extra borrowing, say market participants. However, a senior finance ministry official warned on January 15 that there was a possibility of overshooting the market borrowing target even if the inflows from the 3G auction did not materialise.

Although the market borrowing next year could be far higher than the average of the last five years of Rs 2.08 trillion, a run-away rise in yields is not expected.

Traders say about Rs 1.14 trillion bonds are due to mature in the year to March 2011 and that could slow the pace of a rise in yields. “Bond yields may rise in a knee-jerk reaction to any RBI monetary tightening, but the fact remains that the demand for bonds is not as bad as it is being made out to be,” says R V S Sridhar, senior vice-president of treasury, head of markets, Axis Bank.

The market feels all possibilities are accounted for and, therefore, it is sitting pretty for the next two months. That’s unless, Subbarao does a Y V Reddy, borrowing his penchant for surprising the market.

Oil was the best bet in 2009

Even as gold climbed to a record in 2009, it was oil that was the best choice among major types of investments

(*As of close of US markets on December 31, 2009. Note: Figures include reinvested interest for basket of six other major currencies)