April 19, 2019 (MLN): The ongoing phase of time is an interesting and possibly the most profitable stage for bond investors given that a potential IMF scheme is seemingly at a stone’s throw and the discount rates are afloat to the best of their ability.
The State Bank of Pakistan conducted an auction recently, in which it sold Pakistan Investment Bonds (PIB’s) worth Rs.227.98 Billion for 3 Years (Fixed Rate) and 10 Years (Floating Rate).
This has provided economic analysts with a pool of open ended possibilities to toy with, regarding whether or not investing in bonds this time around would pay off.
Keeping historical trends in mind the discount rate is apparently at its peak right now, given that an IMF agreement is just around the corner. This deduction roots from past trends which tell us that Pakistan’s interest rate cycle hits a pinnacle around the time of an IMF agreement and once it is penned down, the key rates gradually return to the surface over the course of the following few months.
It is also pertinent to remember that since discount rates are at their highest, bonds are priced very low at present. This organically means that once interest rates begin their descent, the bond prices will go up.
These presumptions come together to paint a rather ground-breaking scenario for financiers looking to invest in bonds.
IMF agreements in hindsight:
Pakistan signed a $7.6 billion stand-by arrangement with the IMF in November 2008. The graph above evidently supports the aforementioned argument by showing discount rates at their peak (15%) around the end of 2008 and initial few months of 2009 (until March 2009), before beginning a gradual descent for the next seven months, until November (2009) when it reached 12.5%. The rates remained at this level for the next eight months (until July 2010).
But what gives most weightage to our theory is that the 10 year PIB yield was at summit around the time of agreement, shooting up to nearly 16.7% in December 2008. In fact the bond yield had risen by up to 200 basis points in one month.
Likewise, around the time when IMF deal was penned in mid-2013, the discount rate peaked from 9% to 10% and remained at this level for around a year (until October 2014) before declining rather steeply in the following year and half (from November 2014 to May 2016) to 6.25%. The discount rates remained at this level for another 18 months.
Meanwhile, bond yields marked a peak in the months following the time of this agreement, touching up to 13.4% in October 2014.
Coming back to present:
With another IMF deal on its way, the central bank began monetary tightening in December 2018 when it pushed up key rates by 50 basis points. From then onwards, the SBP has been opting for further fiscal consolidation every two months with its latest hike of 50 basis points in April 2019.
Having pointed out historic trends, it is now easier to see the striking similarity between the current landscape and previous scenarios.
Credibility to this theory is given by the higher participation in recent auctions as the market expects interest rates to start to plateau. The government received bids worth Rs.560 Billion against an auction target of Rs.100 Billion for the Fixed Rate PIBs which carry higher interest rate risk/volatility compared to the floating rate PIB's which received Rs.104 Billion in Bids against an auction target of Rs.100 Billion in the latest auction.
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