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Frontier Trading Insights
In our last FTI report we provided a perspective that the direction of bond yields were more weighted towards a rise within the next 1-3 months. However given the strength of our view, we said “the risk reward outlook on them at present does not lead us to recommend any significant positioning based on them”. Bond yields have broadly remained steady in the last five trading days.
However, we now feel the headline inflation number which came in at a 5-year low in October 2014 could be a catalyst for a very near term dip in bond yield rates. Though a fall in headline inflation was expected due to the downward revision of fuel, gas and a 25% reduction in domestic electricity tariff, the significant decline in the headline inflation under the 2% level is an unexpected positive for rates. Further, food inflation which is now moderating given improved food supply and other positive budget related price revisions could easily see headline inflation maintained below 4% on a Year-on-Year basis till the end of the year.
Further, another positive for rates, is the possible impact on global risk sentiment following an additional of around 20 billion yen being put forward as stimulus by the Bank of Japan. This could see a risk-on global investment sentiment as was seen last Friday, with most global equity markets gaining on this news. Locally, there could be speculation over possible inflows to the market given the possible impact on global liquidity by this stimulus measure. Further, yen weakness is a positive for Sri Lanka given that close to 17% of Sri Lanka’s foreign currency debt is denominated in yen, which might be seen somewhat positively by global investors.
However, this positivity and subsequent risk-on sentiment could be short-lived given the speculation and risks over the monetary policy actions by the Fed and the ECB leading up to their respective meetings in December.
Another factor that could be supportive of bonds is speculation around how the CBSL will be reacting to the latest decline in gold prices. Last Friday it broke the key technical point of US$1,180 largely on dollar rally strength. Further, decline in gold prices could increase speculation that the CBSL might stay longer on the path of loose monetary policy to mitigate the negative impacts of the Gold price fall on the banking sector.
Taking all of the above we expect a near term (within the next month) fall in bond yields between 20-50 BPS. At present the 4-year and 5-year bond yield is trading at 7.15% and 7.30% respectively. The probability we place on this fall in yields is 70%. We have a 15% probability that rates would remain the same and a 15% probability that they could rise within this one month period.
Given this, and the risk reward balance surrounding this, we believe traders should position for a near term fall in bond yields.
As with all our trading insights reports, this is a trading call that could be reversed should conditions change. The biggest risk to this call is our near term assumption, that the current risk on phase of global markets continues for a short period of time and benefits the local government securities market.
Following a near-term dip in bond yields which could see the above mentioned maturities falling under 7%, we expect it yields to rise again on account of the fundamental and global factors we have been outlining in previous reports.
In our last FTI report we provided a perspective that the direction of bond yields were more weighted towards a rise within the next 1-3 months. However given the strength of our view, we said “the risk reward outlook on them at present does not lead us to recommend any significant positioning based on them”. Bond yields have broadly remained steady in the last five trading days.
However, we now feel the headline inflation number which came in at a 5-year low in October 2014 could be a catalyst for a very near term dip in bond yield rates. Though a fall in headline inflation was expected due to the downward revision of fuel, gas and a 25% reduction in domestic electricity tariff, the significant decline in the headline inflation under the 2% level is an unexpected positive for rates. Further, food inflation which is now moderating given improved food supply and other positive budget related price revisions could easily see headline inflation maintained below 4% on a Year-on-Year basis till the end of the year.
Further, another positive for rates, is the possible impact on global risk sentiment following an additional of around 20 billion yen being put forward as stimulus by the Bank of Japan. This could see a risk-on global investment sentiment as was seen last Friday, with most global equity markets gaining on this news. Locally, there could be speculation over possible inflows to the market given the possible impact on global liquidity by this stimulus measure. Further, yen weakness is a positive for Sri Lanka given that close to 17% of Sri Lanka’s foreign currency debt is denominated in yen, which might be seen somewhat positively by global investors.
However, this positivity and subsequent risk-on sentiment could be short-lived given the speculation and risks over the monetary policy actions by the Fed and the ECB leading up to their respective meetings in December.
Another factor that could be supportive of bonds is speculation around how the CBSL will be reacting to the latest decline in gold prices. Last Friday it broke the key technical point of US$1,180 largely on dollar rally strength. Further, decline in gold prices could increase speculation that the CBSL might stay longer on the path of loose monetary policy to mitigate the negative impacts of the Gold price fall on the banking sector.
Taking all of the above we expect a near term (within the next month) fall in bond yields between 20-50 BPS. At present the 4-year and 5-year bond yield is trading at 7.15% and 7.30% respectively. The probability we place on this fall in yields is 70%. We have a 15% probability that rates would remain the same and a 15% probability that they could rise within this one month period.
Given this, and the risk reward balance surrounding this, we believe traders should position for a near term fall in bond yields.
As with all our trading insights reports, this is a trading call that could be reversed should conditions change. The biggest risk to this call is our near term assumption, that the current risk on phase of global markets continues for a short period of time and benefits the local government securities market.
Following a near-term dip in bond yields which could see the above mentioned maturities falling under 7%, we expect it yields to rise again on account of the fundamental and global factors we have been outlining in previous reports.
