The SBP and commercial banks are heads on. SBP through its policy decision and communication attempted to cool off the banks through the monetary policy statement, which included an inherent warning for banks. Finance minister also threatened the banks verbally, chiding them for their aggressive behavior in T-bills auction. All this noise and drama makes the otherwise boring commentary on the money market an interesting one.
Cat is out of the bag. Yesterday, the cut-off yields in the T-bill auction almost remained unchanged from the previous one on 1st December: 3M at 10.78 percent, 6M at 11.50 percent, and 12M at 11.51 percent. Government fetched Rs1,285 billion against target of Rs1,400 billion.
Between the two auctions, there was a monetary policy announcement where SBP attempted to clear the uncertainty, and offered a clearer forward guidance of monetary policy settings to remain broadly unchanged in the near term; with an assertion that mildly positive interest rates on forward-looking basis are now close to being achieved.
Policy rate was increased by 100 bps to 9.75 percent. Based on this, the 3M paper should ideally be around 10.25 percent. Instead, it is at 10.78 percent. The gap between the policy rate and 3M and 6M papers is huge in the 1st December auction. Policy rate was 8.75 percent, and cut-offs were 10.79 percent (3M) and 11.50 percent (6M).
MPS announced on 15th December stated that “across all tenors, secondary market yields, benchmark rates, and cut-off rates in the government’s auctions have risen significantly. The MPC noted that this increase appeared unwarranted”. Nevertheless, the market has not changed its behavior. It appears that the forward guidance has been disregarded by the market.
Not only cut-offs yields remained unchanged, but weighted average yields have increased as well – 3M from 10.39 percent to 10.66 percent, and 6M from 11.08 percent to 11.38 percent. Either market is expecting more rate hike, or it has declared the policy rate and forward guidance irrelevant.
One major reason for this increase is higher auction target on 15th Dec at Rs1,400 billion against Rs750 billion on 1st December. Banks bids were based on their appetite and MoF must accept it. The problem is lack of foresight from government side and lack of clarity on the forward guidance from SBP.
In July, SBP didn’t mention any signs of tightening. Back in September, there was a token increase with monetary policy turning accommodative in the near term. MoF was hoping that rates shall increase slowly. However, market observed the rising trend both in inflation and current account deficit. Government kept rejecting the bids in 6M and 12M papers since September and instead continued accumulating in 3M.
Suddenly in November, the monetary policy was preponed, and rate was increased by 150 bps. In the auction held couple of days before the preponed policy, the market had bid even higher rates. Government rejected most of these bids.
And the situation has become completely reversed in December. Approaching lumped maturities meant that targets rose. IMF programme is back on track. The government has accepted bids at 11.5 percent for 6M. It could have rejected top bids as weighted average was 11.08 percent. But a signal has been sent to the market.
In this backdrop, government and SBP did make some efforts in the last two weeks to calm the market down; but in vain. The question is what happens next. SBP hinted that it has measures in mind to counter such behavior. One is to increase the reverse OMO rate (which is close to the policy rate). The rollover amount is close to Rs2 trillion. Banks rollover these weekly to lend to the government. Their spreads are increasing. SBP can squeeze those by lending through OMOs at higher rate. But if SBP goes down that road, it will make the policy rate irrelevant by itself. This will be a highly risky and unadvisable approach, as it runs contrary to SBP’s goal to bring market rates close to the policy rate.
The other option is of outright purchase of government bills/bonds by SBP from the secondary market. This will not violate IMF’s condition of no direct borrowing of government from the SBP. Such moves are permitted. This space has been advocating this action for the past six months. Now SBP may finally consider going down this path. This may finally calm the market.
There is another big target auction (Rs1,200 Bn) approaching on 29th December. Rates may remain high for this auction before they finally start to taper off a bit in January. Till that time, war of nerves shall continue.
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