As expected, the T-Bill cut-off rates are down marginally in the first auction of 2022. The decline in yields is due to relatively low target in the last auction as compared to the previous two in Dec-21. The other reason for lower 3M yields is the additional amount picked by banks in reverse OMO to lower the naked risk of banks. Nonetheless, the bid pattern, yields in 6M and 12M papers suggests that market is still expecting rate hike in March (SBP has indicated a pause in the upcoming policy announcement on 24th Jan).

The auction target was Rs650 billion, and the government picked Rs662 billion. The bigger chunk was in 3M paper – Rs535 billion at the cut off yield of 10.45 percent. The yield in the last auction was at 10.59 percent and at 10.78 percent in the auction prior to that. The reason for the decline is SBP’s increase in OMO injection duration.

In Mid Dec, SBP decided to increase the OMO maturity to calm the market which was demanding higher rates owing to uncertainty on the inflation and interest rate fronts. The market was not ready to take repricing risk. The liquidity is short – and there is a case of permanent shortage, with OMO injection hovering around Rs2 trillion for a few months. The OMO usually is for a maximum duration of 7 days and its rate is close to the policy rate.

Banks are borrowing from SBP on short-term (7 days) and funding the government for a higher duration (3 months or more). With interest rates expected to move up, banks are asking higher yields than what should be on prevailing policy rate. The cost was borne by the government.

To undo this, SBP increased the OMO for 63 days. There are four auctions of OMO in which 63 days were fetched. The outstanding amount is now Rs1,769 billion – out of total OMOs outstanding of Rs2,090 billion. With every auction, the exposure on 63 days is increasing and that is reducing the repricing risk for banks in 3 months.

That is the prime reason for the decline in 3M cut-off yield. This is evident by the fact that despite 14 bps decline in cut-offs in the last auction, the weighted average (WA) yield is down by merely 2 bps. In 29th Dec auction, government fetched Rs650 billion and Rs553 billion on 12th Jan. Now more people are offering marginally lower rate, and that is because their naked risk is being covered. The good omen was that total offering in the 3M paper was Rs1,167 billion. Market is happy; they got the opportunity to leverage without repricing risk.

Nonetheless, the risk started growing beyond three months. But market is still participating, albeit at higher rates. The offering was Rs647 billion (WA 11.43%) while the government accepted a mere Rs107 billion at the cut-off at 11.37 percent (WA 11.34%) – cut off yield is down by 8 bps from the last auction. In case of 12M, the cut-off yield is down by 2 bps to 11.49 percent while the government got a mere Rs20 billion.

The question is how will the yields move going forward? That depends upon interest rate outlook. For that, the current account is the key to watch. One variable to keep a close eye to determine the fate of current account (and imports) is oil prices. If Brent remains north of $80/barrels, then the SBP and government’s strategy will likely go upside down and rates will move up. Else, all kosher.