Lower bond yields brighten policy easing outlook: analysts

KARACHI: A slowdown in the long-term bond yields is increasing the chances of interest rate cut, analysts said on Tuesday. But, they are divided on whether or not a cut would happen in November or later.

Faizan Ahmed, head of research at Optimus Capital decline in bond yields reflects changes in inflation expectations over the medium to long term.

“The rate decline has more to do with anchoring of medium- to long-term inflation expectations where the SBP (State Bank of Pakistan) has also reiterated in its publications that they are right on track to achieve their target of 5-7 percent inflation and consumer price index will start to fall from the second half of this fiscal year onwards,” Ahmed said. “The SBP’s next move in interest rates is more likely to be a slight cut.”

Pakistan’s 10-year government bond yields fell 90 basis points to 12.24 percent in the auction held on September 18. Yields on 10-, 5- and 3-year Pakistan Investment Bonds averaged at high levels of 13.7 percent, 13.8 percent and 13.9 percent, respectively in July.

The situation, however, changed considerably after 100 basis points increase in the policy rate in July 16 monetary policy review as the market participants thought that rates had peaked. Therefore, yields on long-term papers started to fall and yield curve begun to invert.

“Investors believe that inflation will eventually come down,” Mohammed Sohail, chief executive officer at Topline Securities said. “As a result they are buying long duration bonds.”

Yields on market treasury bills — sensitive to short-term interest rate expectations – also declined across the board in the previous auction. The overall lower trend is unlikely to change over the coming months, with yields for benchmark bonds to fall further. Some analysts see the central bank’s monetary policy committee is likely to hold policy rate in near-term.

“It is speculation by the market that SBP will not increase policy rate in near future as further increase will slow down the economic activity in the country,” said analyst Yaqoob Abubakar from Tresmark, an application that tracks financial markets.

Ahmed of Optimus Capital said the recent rate decline to the tune of 140-170 basis points in longer tenor rate from July indicates the larger extent to which inflation expectations are now anchored into the economy.

“This is not the only reason which the SBP considers in its interest rate decisions so it is important to look at the overall picture rather than just one aspect,” he added.

International oil prices have come down by nine percent during FY20 till date. Net international reserves of SBP have improved. Exchange rate has stabilised. Global interest rates have been slashed. External account has shown improvement, which indicates potential for rate cut in November.

Ahmed said the quantum will likely be lower, say 25 bps, “as SBP will err on the side of caution and continue to monitor high frequency data with greater cuts coming in 2HFY20”.

The monetary policy decision would be taken on inflation situation in the country in which prices of oil matters a lot due to current global situation. Therefore, it would be interesting to see that what the direction of the policy would rate in upcoming meetings, Abubakar of Tresmark said.