Thursday, December 3, 2009

October 2009 Monetary Policy Update

As expected, M1 growth fell down in October compared to September - the Raya effect in full force (log monthly changes):

Year-on-year however, we get the base effect, with growth ticking up to more normal levels (log annual changes):

With 3Q GDP numbers now up, I got the chance to update my velocity estimates (details here), which are still falling despite economic activity picking up:

However, the implied velocity growth (from changes in money supply, output and inflation) is still higher than actual (-10.8% versus -19.6% for 3Q 2009), which suggests the monetary policy stance is appropriately looser than strictly required for a growth-neutral stance.

Loan growth is within the norms of the last few years, so excess money supply growth is being channeled through into the economy (log annual changes):

...even if banks are still keeping a lot of money aside (reserve deposits of FIs with BNM, RM millions):

On the interest rate front, average lending rates have settled at about 2.9% over interbank overnight, which seems a bit excesive to me given the continued downtrend in NPLs:

That kind of spread would be justified if defaults were rising, but since they're not, we're still looking at some "fear" in the banking system, and possibly caution among consumers and businesses - in other words, money demand is still high in the system.

There's also been a lot of movement in the MGS market:

Yields have gone up for all maturities, despite net redemptions in October (RM millions):

...and November trading has added a further 10bp-40bp to yields. That's bad news - prices falling despite a reduction in total supply implies an even sharper reduction in demand. This would be understandable if we're looking at year-end window dressing, but it's a little premature for that to happen now. I can't think of any recent news that would justify this movement (Dubai was too recent, as was Prof Ariff's call for a third stimulus), except that possibly investor perception of the government's underlying risk premium has changed. While this won't much crimp the government's ability to borrow, it is a signal that the market's capacity is not unlimited.


  1. bro hishamh on the MGS curves.. apepasai short end slope tinggi sangat

  2. Funny innit? Not quite unprecedented though - you can see the same pattern on the short end during 1999-2000, around the time of the last recession.

    A couple of things I think the market is thinking:

    1. Inflation outlook is uncertain, but looks like the market is expecting a return to more "normal" price inflation over the short term horizon, but slowing thereafter (mirroring outlook for the OPR).

    2. Government borrowing plans are uncertain over the short to medium term, but with an eye towards fiscal consolidation afterwards, hence spread compression on the long end.

    I'm also thinking that BNM will probably tighten a lot faster than most people are expecting.

  3. 99-00 was just after the massive shock on the short end during the was very jittery ...would that be comparable to early part of 2009?

    do agree on your 1 and 2...

    was there a consistent big seller in the market? how's the big boys's holdings n foreign..stable?

    there was always a pivot point somewhere around 5 years market churning by PD's to meet minimum volume...

    always wondered if OPR can work in "unstable" markets.....could it be that the OPR itself is the cause, depressing the shortest end n market pening kepala to adjust?

  4. bro, I have no idea how to check on actual holdings (or volume).

    OPR is just establishing the lower base for all interest rates, but particularly the short end. Long term rates are a function of relative debt outstanding.

    Looking back, you have to relate what's happening to the execution of monetary policy.

    1998-2005, we're under a fixed exchange rate regime. Since the exchange rate is the primary instrument, that implies volatility in interest rates and money supply (which is what has happened. Hence you will see extended spreads between MGS maturities (steep slopes).

    Since 2005, we're under a flexible exchange rate regime with the OPR as the primary instrument. Under those circumstances, you should see volatility in the exchange rate and money supply, which is also what has happened, at least up til end 2008 when the govt started borrowing for stimulus purposes.

    If we were money base targeting, you'd see fx and interest rates going cuckoo instead.

    So what we are seeing now is I think real uncertainty on all fronts and for all maturities, with obviously higher demand on the short end and lower demand on the long end.

    That means that once things settle down (mid-2010 is my guess), with a better idea of the inflation/OPR outlook and future govt borrowing needs, I expect the yield curve to flatten again (spread compression) - bear market in the short end and (small) bull on the long.

    Note that the total spread (short to long) is still smaller than it was during the fixed rate period.