Currency Market Update 20-Dec: Operation Twist is here to stay!

Bank of England has kept its monetary policy stance unchanged with interest rates at 0.75%. It is noteworthy that 2 MPC members had voted to cut interest rates on ground of falling inflation and loosening labor markets. BoE expects inflation to ease further to 1.25% before rebounding next year. Consequently, GBP/USD fell further to its two week low levels of 1.2990 and the pair has immediate support at 1.2970. On other hand, US dollar index was seen recovering to 97.40 levels. US dollar index will take further cues from final US GDP numbers, which is expected to print at 2.1%.

On domestic front, RBI has finally ‘bitten the bullet’ by announcing its version of Operation twist. RBI will buy INR 100 Bn on the run 10 year paper 6.45%GS2029 and simultaneously sell various 2020 maturity bonds. This special operation intends to flatten the yield curve without affecting the INR liquidity. It is noteworthy that RBI has been finding it difficult to transmit its rate cut actions with 10 year bond trading near 6.75%, before operation twist, while repo rate at 5.15%. This 160 bps spread, between 10 year bond yield and repo rate, suggests a lack of transmission in markets and increase in credit and tenor risk premium. Domestic 10 year bond yield opened nearly 13 bps lower at 6.62% against previous close of 6.75%. A closer look at details of operation suggest that RBI is buying single long term paper and selling 5 different short term papers, thus intent seems to be higher impact on long term and lower impact on short term. It also seems that this operation is not one-off and RBI might further announce such twist operations. On currency front, USDINR opened the session at stronger note at 71.15 against previous close of 71.04. PSBs have been intermittently buying currency future on exchanges leading to rally in USDINR pair. USDINR pair has first support at 70.97-71.00 levels and first resistance at 71.30-71.35. Range for day 70.97-71.35.