The market rates are moving up. The policy rate at current levels was totally disregarded by the market. In the latest T-Bill auction, government mainly confined itself to fetching 3M paper as the yields offered on 6M and 12M seemed too high for government to accept. The good thing – as advocated in this space (for details read “OMO’s What’s cooking”, published on 27th October), is that there is interest in 2Y floating PIBs. It is a no-brainer for banks to invest in these papers and it is good for the government to improve its debt maturity profile.
In the T-Bill Auction earlier this week, government fetched Rs285 billion against the target of Rs500 billion while the participation was Rs753 billion. Government accepted Rs281 billion (including Rs36 Bn non-competitive bids) in 3M at a cut-off yield of 8.5 percent – 25 bps higher than previous cut-off, and 125 bps higher than the prevailing policy rate. In 6M paper, government accepted a token amount of Rs3.4 billion just to give a cut-off of its liking at 8.5 percent.
The serious bids were offered at 8.9 percent and above. Then the government rejected all bids for 12M where serious buyers were offering 9.25 percent and above. The cat and mouse game is back in action – the usual story when interest rates are expected to move upwards.
The good thing is that in 2Y floater government accepted Rs144 billion out of Rs163 billion bids. Its good to see that banks are participating, and government is accepting. Banks usually demand premium for higher tenor bonds in days of increasing rates and government is usually reluctant to accept rates beyond a certain premium to the policy rate. And eventually, banks get loads of bonds at peaking rates and taxpayers pay higher cost till maturity. This happened as recently as in 2019 and 2014.
In case of floaters, rates are linked to short term papers, and the interest rates changes half yearly, quarterly, or even fortnightly. There is no or little interest rate risk in floaters for banks while government maturity profile improves. 2Y floater is linked to 3M TB plus 40 bps spread over weighted average yield. For example, the floater rate in this auction is 8.65 percent (as weighted average yield of 3M paper was 8.25 percent). Its coupon is quarterly and is repriced fortnightly. For example, if rates move up in the next T-Bill auction, floater rates would move up too. With a kind of volatile interest rate market in Pakistan where banks have almost absolute power in determining market rates, PIB floaters are the most appropriate instruments.
Nonetheless, market rates in the secondary market have moved up from 69 bps (3M) to 89 bps (10Y) since the last monetary policy and this implies that another 75bps increase in the policy rate is already priced in. Expect SBP to increase the rates by 50-100 bps in the upcoming policy review. The good sign is that overheating in bonds (over 1 year maturity) is cooling a bit. For instance, since mid-October, the yields in 3Y and 5Y papers are down by 39bps and 55bps, respectively. The external account support from KSA and possible deal with the IMF is easing the market on the overall rate increase. But 3M and 6M papers yields have moved up 34 bps and 38 bps since Mid-October, while 12M is unchanged.
The yield curve is getting steeper in the short term while its relatively flattening in 1Y to 10Y papers. But still, it is steep. It seems that earlier market was expecting higher increase in this cycle and now probably the expectations are for policy rate to peak around 9.5-10 percent by June-22.
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