The Treasury bills yields are falling in anticipation of rate cuts. In the auction earlier this week, the cut-off yields were down by 50-54 basis points (bps) to 18.97 percent in 3M and 17.73 percent in 12M paper, as opposed to the policy rate of 19.5 percent. There are multiple reasons for this. One obvious one is expectations of further rate cuts, and the other subtle one is to manage the Advance to Deposits ratio, as there is a higher tax on banks’ gross income from investment in cases of low ADR.
Nonetheless, almost everyone in the industry expects a rate cut of at least 3-4 percent until the upcoming summer, and they are willing to accept a short-term loss of 190 bps (the difference between the 12-M T-bill cutoff and the OMO auction rate), given the expectation of future rate cuts.
“We expect gradual easing in interest rates, and we see the Treasury bills rate at sub-15 percent in the 2HFY25,” said an asset management company CIO. “We reassess the conditions at that time when the yields reach 15 percent,” the asset management company CIO continued.
The market echoes this sentiment. Everyone expects inflation to decrease, and based on real rates of 3-4 percent, they anticipate interest rates to drop to around 15 percent. Participants anticipate a negative spread of 190 bps until the next policy rate on OMO in the 12M paper, marking the peak of both participation and acceptance.
Interestingly, the treasurer of one bank believes that the management of the forex market is causing a decline in inflows within his bank, while the SBP is maintaining currency stability through the management of forex flows. He asserts that leaving the forex market to market forces could lead to a decline in the currency’s value, which could negatively affect inflation and cause real rates to fall, contrary to popular belief. “When you have administered currency, you do not have any choice but to keep real rates high,” he concluded.
A few other banks’ treasuries agree with the SBP policy of maintaining positive real rates, but they believe that the market’s demand is stagnant due to high inflation and taxes, and that the forex market’s supply and demand are in equilibrium with no administrative control. Well, the views vary depending on the bank’s positioning; those who rely on remittances and exports are in the positive, while banks that focus on imports and trade fall short of liquidity.
“Money markets will remain bullish as a 4 percent cut is priced in. If the US delivers a 75-100 bps cut by December, it could lead to further easing in Pakistan, according to a bullish treasurer.
There is a rumor in treasury circles that some banks have decided to reduce their investment in government securities to increase the advance-to-deposit ratio. This decision was made due to the higher tax on lower ADRs, particularly those on gross income. One Treasury officer lamented, “There’s no fun in using OMOs to fund the government when they’re eating up half of the gross earnings.”
Some banks have extremely low ADR and heavy bookings in OMOs. There is a rumor that this bank is planning to reduce its high-cost time deposits and encourage its clients to directly invest in T-bills through non-competitive bidding. The reduced deposits will improve ADR at current advances. Others may do follow suit going forward.
In the last auction, non-competitive bidding was Rs95 billion, which is 27 percent of the total auction size of Rs355 billion. This ratio is higher than the previous 24 auctions, where the average stood at 17 percent. However, in absolute number, Rs95 billion is in line with the average noncompetitive bidding of Rs98 billion in the last 24 auctions.
The government has played a beneficial game. This would not only entice banks to focus on deposits but may also push high-net-worth clients to directly invest in government papers. Interesting times ahead.
Comments