Thursday, March 5, 2009

The Yield Curve

As if we need more confirmation we're in trouble:

The chart shows the spread between (average) interbank rates for overnight, 1 week and 1 month money. While the spread between overnight and 1 month money was flat throughout 2008, the spreads between overnight and 1 week against 1 month money both turned negative in November and January 2009. In other words, money is cheaper in the future than it is right now, or equivalently demand for money now is higher than demand for money in the future. From a term structure perspective, the yield curve (the ranking of interest rates based on maturities), which would normally be upward sloping to reflect risk and inflation expectations, has inverted. The interpretation for a yield curve that gets flatter can vary depending on the situation, but generally follow along these lines:

1. The market is pricing in an interest rate cut
2. The market is expecting deflation/reduced inflation
3. The market for whatever reason desires short term liquidity

An inversion of the yield curve is more serious, and is usually taken to be a recession signal. Admittedly I'm basing this on just a couple of data points, but given the other data, I'd take this as weak confirmation we're in a technical recession. For comparisons sake, here's the situation around 1997:

Please note the differences in scale between this chart and the previous! If anybody's wondering why I haven't charted any maturities longer than 1 month, it's because the market for 3 month and longer terms has almost completely dried up.

In complete contrast, spreads in the market for MGS have widened instead:

This represents the long end of the money market, looking at spreads between the indicative yield of 1 year MGS against 5, 10, and 20 year maturities. Off the top of my head, I'd say the market is pricing in the likelihood of higher government borrowing (which would raise yields) as well as a flight to the short end, though not yet looking at potential higher future inflation.


satD asked for the risk premium between the interbank market, BNM Bills and Treasury Bills, but it's not terribly informative:

The empty spaces in the chart reflect lack of trades in those periods, especially in the interbank market. There is however, further proof of flattening/inversion in the yield curves of both BNM bills and T-bills (spreads are between 3 month and 6 month maturities):

I'm not even going pretend to know what went on in 2005 for T-bills, though (there's also another sharp downward spike in late 2004).



    What's the spread between interbank Vs BNM or TBills of corresponding maturity?

    This will be a better indicator to know why the driver of "inversion"? If market participants become less confident of lending to one another then generally everyone will congregate on the short end even if there is ample liquidity.

    the situation in 97/98 is extreme from data point perspective.. a huge number of players were technically insolvent resorting to borrowing direct from Negara..are we now heading there?

    BTW does negara guarantees "interbank" lending as part of crisis measures?

  2. bro

    I wonder what you make of this idea of re-pegging the ringgit.

    Edge Daily piece

  3. satD: What you're asking for is the risk premium, it's not quite related to the inversion of the yield curve I'm discussing - but this is a good point nontheless. Unfortunately, I can't comply because the maturities don't match except for 3-month money, which is highly illiquid.

    On the other hand, the inversion of the yield curve is even stronger in these securities. I'll update my post to reflect that.

    de minimis: I think some reporter had nothing better to do ;)

  4. satD: Sorry I missed your last two questions. On the first, no, the situations now and in 97/98 are completely different. We had serious NPL problems then, which killed a lot of bank capital ratios (like we're seeing now in the US). Malaysian banks now aren't carrying that sort of risk as yet. NPLs should rise, but there's little risk of a fall in house prices so consumers aren't going to be a source of trouble (credit card debt in this country is low). Manufacturing loans are what we need to look at.

    On your last query:

    "all ringgit and foreign currency deposits with commercial, Islamic and investment banks, and deposit taking development financial institutions regulated by Bank Negara Malaysia, will be fully guaranteed by the Government through Perbadanan Insurans Deposit Malaysia (PIDM) until December 2010. The guarantee extends to all domestic and locally incorporated foreign banking institutions;"

    which I take to mean yes :). The link is here. Whether PIDM has sufficient funds to cover potential losses is another thing entirely.

  5. thanks a bunch hishamh been so out of touch of KL data. You are doing great work here for a lot of people. Will u be updating ur charts?

    Tks again hishamh


  6. You're welcome.

    I'll only update them (publicly that is) if I feel it's necessary and/or interesting. Who wants to work at this stuff anyway? Feel free to ask if there's anything you'd like to see.

  7. wah that's excellent will drop by for sure to mintak tolong with data.

    Wondering if u have rate of increase of inflation adjusted M3/IPI?

  8. I'll address that in a future post - that nicely addresses what's been happening to velocity.

  9. tks for d charts...putus putus :C

    Do u hav bid offer spreads in interbanks?

  10. tks hisyamh

    Wud b a nice proxy for credit risk n liquidity

    For d tbills does negara publish holdings data by investor type/localforeign breakdown. That would really help to add some perspective.

    Aggregates are provided I think for head of treasury briefs then donno about now

  11. Report 6.6 in the BNM's MSB, available online:

    FWIW, the breakdown for TBills is superficial, MGS has more info

  12. tks hishamh

    6.6 shows a constant total of 4.320 (for real??)

    tried to consolidate with report 6.8 which gave foreign holdings...large portion seems to be in BNM Bills n MGS which shown significant drop from July 08...

    will check with some friends in the market on the inversion....

  13. I checked the back issues of the MSB, yes that total is correct.

  14. market source indicate that situation is temporary due to medium to long term potential oversupply situation in MGS for deficit financing...most are just congregating on the short end of the curve to buy time.

  15. That explains the steepening of the curve in MGS - thanks. I see banks picked up RM26.5 billion in MGS between August and January.