Interest Rates and Yield Curve in February 2009

Since last night's release of the BNM Monthly Statistical Bulletin, I've been busy updating my databases. My planned post on forex regimes will have to be put on hold while I digest (and regurgitate) all this new data - so there will be a bunch of stuff coming out on this blog over the next few days.

First, spreads in the interbank market in February have returned to positive again but just barely:



Looking at the levels, we can see here the impact of the cuts in the OPR on interbank rates:



The yield curves on BNM bills and TBills remain strongly negative however. On the other hand, given the anticipation over the stimulus package (remember, we're looking at February data here), the yield curve for MGS steepened sharply:



I know it looks like a bunch of spaghetti thrown by a patricidal 3 year old, but there's actually some sanity in the chart. Each line represents the indicative yield for a particular MGS maturity, which ranges from 1 year to 20 years. Lines moving closer (or crossing over) means the yield curve is flattening or inverting, while lines moving apart means the yield curve is steepening.

There's a sharp drop in yield at the short end, and an increase in yield at the long end. Some interpretations:

1. Flight to liquidity (risk aversion) - the market wanted more liquid instruments as economic news worsened. Prices would then be bid at the short end compressing yields, while the opposite would happen at the long end.

2. Anticipation of new supply - there was a lot of speculation over the size of the stimulus package, which had particular implications for 3 year maturities and above. Greater supply of bonds relative to demand would of course reduce price, and increase the yield.

3. Anticipation of inflation - under normal circumstances, a steepening of the yield curve would signal expectations of future inflation. Since the times aren't normal, and we're likely to have 2009 GDP under the full employment level, I'd discount this - for now.

Data from March (available here) indicates 10 year MGS yields falling back a bit, while yields on 3 year and 5 year maturities going up about 30bp.

Be that as it may, what worries me is that the spread hasn't been this high since the USD peg was abolished:



That reflects a lot of continued uncertainty in the market (higher risk premiums demanded, not inflationary expectations), and just as importantly makes capital market borrowing for the government relatively more expensive. Our soon-to-be PM's little comment about RM200 billion extra for the 2010 budget doesn't help either.

There's enough liquidity in the market to fund the RM35 billion required by the 2nd stimulus package, but I'm starting to think that a syndicated term loan from the banks (as happened in 1998) might begin to make sense soon, especially if BNM cuts the OPR by another 50-100bp.