Negative yield curve – further easing ahead?

T‐bill Auctions – 1Q shows two striking trends

In a T‐bill auction held yesterday, the govt raised PRs167bn vs target of PRs150bn amidst heavy participation of PRs187bn. Cut‐off rates for 6M and 12M edged up by a nominal 2bps to 13.3015% and 13.4026% respectively, while yield for 3M remained unchanged at 13.0697%. To date, auctions in 1QFY12 (targeted amount for the quarter PRs750bn, Maturities PRs701bn) were characterized by heavy participation in 12M bill followed by 6M tenor. This follows another striking trend in last couple of weeks where longer tenor instruments (5‐10yrs PIB) are trading at lower yields than T‐bill rates (see yield curve shape alongside).

Why yield curve matters?

The shift in participation towards 12M highlights banks’ expectations of future monetary policy easing. At the same time an inverted yield curve has been (1) a signal of lower interest rate in the future as longer term bonds become attractive and yields fall further, and (2) is considered a predictor of economic slowdown in developed economies. We flag that the current pattern of yield curve is partially inverted, with 10yr PIB at ~21bps and
~26bps discount to yields on 6M and 12M T‐bill respectively, attributed to (1) lenders’ concern over inflation persistence to have subsided for the time being, hence allowing no premium on longer tenors and (2) could also be a function of demand and supply. Moreover, a similar type of negative yield curve occurred in the beginning of the previous monetary easing cycle in Pakistan during Apr‐Sep 09 as well (10yr‐12M spread went up to ‐75bps).

Monetary policy: Expect another cut…

We believe another reduction in discount rate by 50bps to 13% could be on the cards in the upcoming monetary policy statement due by end‐Sep11 as fundamentals from the previous MPS remain intact. Note that the upcoming meeting with the IMF during Sep 23‐25 at the sidelines of World Bank‐IMF annual meeting could factor in some positive news flow regarding (1) possible extension of current SBA expiring in Sep‐11 or (2) another loan program. This will in turn have important implications for currency outlook, as the recent weakness in rupee parity (‐ 1.4% since end July) remains a key risk to easing cycle for now.

…as inflation and govt borrowing show sign of slipping

Weekly SPI trends suggest that the rise in food prices witnessed in Jul‐11 (food inflation of 3.2% MoM) slowed in Aug‐11 which bodes well for CPI for the month, given that gas tariff hike by 13.55% is expected to push up CPI by ~40bps. We expect CPI to clock in ~13% for Aug‐11. Moreover, we reiterate that further decline in YoY inflation expected in Sep‐11 and beyond on account of high base comparison from last year supports the current easing cycle. Govt borrowing on the other hand has also remained in check at PRs1,157bn as of Aug 20 (+PRs2.4bn FYTD).

KASB Securities & Economics Research

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