The MoF is one up. Market is one down. The PIB auction earlier this week surprised everyone, but it should not have come as a shock. The SBP and MoF finally took a right decision in collaboration of each other by inverting the yield curve (3years to 10 years) and is flattish up-to three years.

Some say that inversion of yield curve is an indication of recession. The Pakistan market is not sophisticated enough to give that signal. Moreover, inversion was due for past many months, meaning economic slowdown was already visible - it is a reactionary step in a thinly traded market where a selected club of bankers drive the so-called market.

In developed economies, the market signals the future behavior. In a small market where players can be counted on fingers - the market moves with a lag. And inverted yield curve is a sign of recession when short term interest rates are in median range. In days of peaking interest rates, an inverted yield curve is a healthy sign. This implies that the SBP/MoF expect inflation to remain high in short term and longer term inflationary expectations are low - a sign of stability in an already depressed market.

In more developed markets, the MPS decisions are based on demand driven factors i.e. when the economy is overheating as GDP is growing higher than what can be supplied. This could fuel inflation and to counter that, interest rates jack up. In Pakistan, the MPS decision is based on the balance of payment situation, not based on demand. For instance, the economy started overheating in FY17, but BoP cushion was enough to not let the SBP tighten the screw. Pakistan has severe external crises, and reserves are running down, SBP is hawkish despite the fact that demand is already suppressed.

The other approach to rely on market for rates in Pakistan is not right. How can a small group of primary dealers decide the market direction? It is a small club and their interest is to pick as many long term fixed rates bonds in peaking interest rates to make bucks in years to come by having high spreads on short term maturity deposit base. The 10-year paper is ideally not for banks, it is primarily for insurance companies, pension funds and mutual funds. Banks are showing big appetite to make quick bucks on taxpayer money without really delving into what is termed as commercial banking.

In the auction, highest participation was in 10-year PIB at Rs205 billion while the government lifted Rs19.6 billion at 13.6%. Government’s objective was to at least remain close to the auction target and they did by picking more in 3 and 5 year paper rather than 10 year paper and that has inverted the yield curve. The secondary market yields, yesterday came down further from the auction cut off - further inverting the yield curve.

The SBP is signaling that high inflation in FY20 is going to a blip and in future, inflation would be lower. Some say that under the IMF, government has to pick higher PIBs in coming auctions. There are similarities to latest auction of what happened in Egypt last year, where the government kept on rejecting 5 and 10 year bond.