September 11, 2019 (MLN): After months and months of fiscal consolidation to control the ever-rising inflation in Pakistan, the general market finally rejoiced when the Consumer Price Inflation (CPI) figures for August 2019 were recorded at 10.5% (Year-on-Year), a figure that falsely depicted a sharp decline in inflation growth.
What the majority belatedly realized was that the narrowed growth was mainly a result rebasing of CPI from year 2006-2007 to year 2015-2016.
While there is a difference of around 1.10% between inflation figures rebased from 2015 versus the 2008 dataset, an analysis of each dataset independently shows inflation on an uptrend.
The dataset with 2015 as base year shows that the year-on-year inflation increased from 8.40% in July to 10.50% in August, which is a greater increase than the 2008-based CPI numbers which went from 10.30% to 11.60%.
Many in the financial market incorrectly compared the July inflation numbers from (2008 as base year) to the August figures from the new rebasing date (2015), which showed a smaller than expected increase. These people then opined that since the inflation has successfully been arrested, the central bank will announce a rate cut in its next Monetary Policy Announcement.
To recall, the SBP began fiscal consolidation in December 2018 in order to slow down inflation and to improve the trade deficit. Resultantly, the policy rates have been on a rise ever since.
On the other hand, the narrowed Current Account Deficit (CAD) along with the stable PKR rates also point in the direction of a rate cut this time around.
However, the CAD was relatively small in July due to some unusual circumstances with lower imports and higher remittances because of Eid. The lower import trend is set to continue in August because of the large number of holidays during the month.
Similarly, PKR is relatively stable at the moment because of the low demand for Dollars, which is expected to continue until at least end of September according to treasury dealers.
Despite these reasons, the monetary policy is expected to stabilize in the near term. In reality, interest rates have been declining in the secondary market since the SBP Governor said that inflation is expected to start slowing down from the second half of FY20.
Due to this, the PIB & T-Bill Auction has seen greater participation, especially in longer tenors, with a modest decline in cut off yields in 5 and 10 years in the most recent auction.
This reiterates what team Mettis pointed out a few months ago in its article titled “PIB Investors to hit the Jackpot!” where opportunities for bond investors were discussed in detail.
As highlighted in the article, past trends have supported the theory that the recent deal with the International Monetary Fund (IMF) means that discount rates are at a peak right now.
In the most recent auctions, the Secondary Market yields for T-Bills and PIBs have decreased across most tenors during the week.
Yield for 1Y T-Bill decreased by 22 basis points, 3Y PIB yields fell by 72 basis points, 5Y by 58 basis points while 10Y PIBs decreased by 29 basis points.
This cut will directly translate into higher prices for long term bonds and automatically makes the present, the best time to invest in bonds!
When the interest rates were expected to rise, bond investors’ participation remained inclined towards the short term securities. MTB Auctions held on August 7, 2019 bear witness to this statement as SBP received bids worth Rs.1.23 trillion for 3 months, Rs.35.6 billion for 6 months and Rs.186.3 billion for 12 months.
However, now that the market expects interest rates to stabilize, the participation in long term bonds has risen sharply as was evident in the MTB Auctions held on August 28, 2019, where the central bank received bids worth Rs.236.44 billion for 3 months, Rs.6.3 billion for 6 months and Rs.703.2 billion for 12 months.
Having said that, the ball is still in the Central Bank’s court as all eyes are fixed on their next policy rate action to be decided in the Monetary Policy Committee meeting, which is due to take place sometime in the coming week.
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