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Investors’ anxiety over the direction of interest rates has been rather apparent on the yield curve.
Demand, notably for longer term papers, has considerably ebbed as players wait for some clue on the exact course of interest rates amid divergent signals from monetary and fiscal policies.
Caution may be further necessitated by prospects of higher inflation, given the negative impact on investor real returns.
At the same time, prospects of a dilemma for policy makers given the need to contain inflation expectation on one hand and stimulate growth on the other, cannot be gainsaid.
Inflation rose in the last two months to 5.56% and could accelerate further in coming months.
Increase in food prices has quickened in recent months driven by the combined impact of a fragile food situation in some counties due to prolonged dry conditions and supply constraints of short-maturity fruits and vegetables due to excessive rains. This is expected to persist unless substituted by considerable amount of food imports.
Meanwhile, oil prices have been on the rise driven by expectations of tighter markets. Earlier this month, OPEC agreed to cut oil output further causing prices to rise by 8.33% on a month-on-month basis.
Moreover, expectations of improved demand as the global economy stabilizes have also anchored oil prices.
On the demand side, the removal of the interest rate cap has increased confidence around the central bank’s ability to influence aggregate demand by altering the policy rate and through forward-looking interest rate guidance.
To this end, the 50bps reduction in the central bank rate (CBR) to 8.50% in November which came hot on the heels of interest rate cap repeal could enhance consumer demand, pushing prices of some commodities higher.
That said, higher inflation expectations will sustain the pressure on the curve as investors seek to cushion their return on investment.
By all accounts, it seems that the regulator may have a difficult time replicating the enviable stability of 2019. Against this backdrop, investors may continue to underweight duration.
NCBA Research, NCBA Weekly Fixed Income Report – 24 December 2019.
