Yield curve inversion continues

The inversion of yield curve deepened in the last week’s PIB auction. The assertion that interest rates may come down significantly in the next calendar year is affirmed. Some say that inversion of yield curve is a sign of recession coming in. That is not correct in Pakistan’s context today. The economy is already in recessionary cycle. With stabilization setting in, growth is likely to pick up next fiscal year. The falling PIB rates are reflection of short term inflationary pressure driving up short term rates. Inflation may come down to single digits in a few months. Rates may decline by 200 bps in 12 months.

The 10-year paper is trading at 10.99 percent. It is 236 bps lower than 3M paper trading at 13.35 percent. In March 2019, the 10Y PIB was at 2.43 percent premium to 3M paper. At that time, market was trying to bid fully for long term paper to lock in at peaking rates. Banks got the flavor of blood in 2014 and the hunger was there.

In the process, banks became greedy and debt office at ministry of finance along with SBP outsmarted the market by accepting lower amounts in successive auctions to anchor the expectations of falling long term rates. The greed converted into fear and now the 10Y PIB discount to 3M TB is at historic peak. Now the catch is to lure the foreign portfolio investment in PIBs.

At this point, virtually all of the $1.2 billion of portfolio investment is in T-Bills. Shorter the tenure, higher the metaphoric temperature of the hot money. Earlier the amount was coming in 3M paper and now more flows are in 12M paper. The natural progression is to dive in longer term. One of the reason foreigners were shying from PIBs was that yield curve had already inverted. The thinking of hedge fund managers could have been to milk short term papers till the time rates are high. Since the cut in rates are already priced in PIBs, it is rational to wait for taxation issues to resolve and for stabilization to be cemented.

But now an element of fear could be seeping in foreign fund managers. The currency is expected to appreciate in the short term. Inflation next year could be lower than earlier expectations. Based on these, return in dollar terms could be peaking now. This may be the best time to enter. Anticipating this thinking of foreign funds, local had participated heavily to not miss the bus.

The SCRA account to date is showing only $7 million PIBs flow in Dec-19 to date. Foreigners have refrained from investing. Some say that they are getting uncomfortable due to delay in abolishing WHT on PIBs.