June 2010 Monetary Conditions Update

Despite three consecutive 25bp hikes in the Official Policy Rate, growth in M2 is keeping pretty steady (log annual and monthly changes, seasonally adjusted):

Much like last month, most of the action is happening on the interest rate front, with rates at the short end continuing to climb across most markets in response to the new level of the OPR:

I continue to find the flattening in the yield curve in MGS fascinating. May’s impetus appeared to be due to higher demand coupled with a reduction in supply due to redemptions – that’s no excuse for June. I suppose at the very short end the rise in yields could be due to BNM’s draining of liquidity via open market operations (more on this in the next post), but the drop at the mid-to-long end of the curve isn’t fully a demand and supply story. Net public sector borrowing shot up RM10.9 billion in June (RM billions):

…yet both issues were heavily oversubscribed, so demand is still there. I think in some form, what we’re also seeing concurrently is a drop in the term risk premium i.e. people are getting more comfortable lending long to the government. Equivalently, traders are feeling safer and exiting the short end to buy longer dated maturities. There’s still an element of fear involved here (witness the wider spreads right now compared to 2006-2007), but I’m betting convergence will continue as long as we don’t get another crisis blowing up somewhere.

Three last charts before I end this post:

The real interest rate (here defined as average lending rates less core inflation) has been rising and is now over 90bp higher than it was a year ago. The spread between lending rates and wholesale funding on the other hand has fallen a little less than that, at about 45bp to 2.6%. That implies that banks are expecting much lower default rates than they thought they might be facing (check this post for the rationale) – on the other hand, we’re also looking at margin compression, so commercial banking profits should consolidate for the year.

Last chart (I promise – really!), comes courtesy of a Morgan Stanley post last week. They’ve come up with a measure of “excess liquidity” using M1 as a ratio to nominal GDP, which indicates the amount of money that actually gets into the economy as opposed to being hoarded as banking reserves. I made the same calculation for Malaysia:

Note the big jump in late 2008 and the less than corresponding contraction in late 2009. Unlike the US and UK however, where quantitative easing was part of the policy menu, our excess liquidity ratio was largely a factor in movements in nominal GDP and not BNM pumping cash into the economy. That suggests, to me at least, that money demand rose much faster than BNM was prepared to meet in early 2009. Equally, I think the ratio will probably fall back to “normal” later this year. Still, this is an interesting idea to look at, especially if movements in the ratio are driven by changes in M1, rather than the denominator.