Yields on government securities are expected to go up further towards the long end and as a result it will be wise to concentrate on short-term maturities, according to the fixed income strategy issued by Merrill Lynch for this month.

According to the investment banking outfit, the reason for the shift to short term maturities is that the short end of the yield curve is expected to be relatively insulated from the overall weakness as "liquidity and shifting market preferences support this segment."

The steepening of the yield curve is due to the term spreads widening especially in the 10 and 20 year segments.

Surplus liquidity and lower dated security supply are the two positive factors that will continue to support the market in the near term.

In fact easy liquidity, negligible supply and shifting market preferences will keep the yields supported during this month.

In the near term, the outlook on gilts has changed from bullish to neutral but the market has yet to adjust to it.

This could take time and price action could be supported by easy liquidity. However, according to the firm, there are increased risks to long maturities and it has advised reducing exposure to longer maturities.

"Higher cash and lower duration is advised to take advantage of volatility and as a hedge against a possible rise in yields at the long end of the curve."

There is another reason for the switch to short term maturities -- these will likely stay supported as liquidity continues to remain easy and as more market participants switch to lower maturities and reduce duration.

Segments upto 2013 are not likely to be impacted by a weakness in the market.

As risks increase, term spreads will likely widen and yield curve could likely steepen. Longer segments where secondary liquidity is low should be avoided," said the firm.

Global central banks might soon start to move to neutral levels. In fact, according to the firm, it will be better to stay invested in up to the 10-year segment.

The market is expected to, "enter an adjustment phase in the short run as the changed sentiment and realisation of a neutral outlook on gilts keeps yields trapped in a weak range."

So far as the money market is concerned liquidity will be easy during the month. Inflows of Rs 9500 crore (Rs 95 billion) are expected.

"Increased government spending, forex inflows, portfolio flows and other remittances should add to the overall liquidity conditions," the analysis said.

"T-bill yields will likely be range-bound as an unchanged repo-rate and easy liquidity should keep demand around 4.5 per cent levels," the report said.

According to the analysts with the firm, it is unlikely that the market will buy t-bills aggressively below the repo rate.