Future movement of Treasury yields may prove favourable for equity investments

Asia Wealth Management says the future movement of Treasury bill yields is likely to prove favourable for equity investments. This view was shared by Asia Wealth in its outlook for the stock market for this week. Here are excerpts:

 

It is noticeable that yields on Government securities in the primary and secondary markets are showing an opposite movement in recent trades. Secondary market yields on long term maturities were on the rise during the past two weeks while primary auctions have shown yields dropping across all maturities.

This opposite movement between primary and secondary yields is due to the fact that secondary market transactions are governed by the direction set by market forces while in contrast, monetary authority bears a degree of control over the primary yields mainly through access to funds of two State banks which account for over half of the banking assets in the economy. Further, monetary policy review for January 2013 states that CB intends to maintain the YoY growth of credit to private sector at around 18.5% in 2013 despite removing the ceiling imposed on private credit expansion. This would transfer loanable funds available from the private to public sector at rates below the market optimum rate. Coupled with the unchanged policy rates it would further mean that market interest rates is likely to remain at current levels and is unlikely to follow the sharp downward trend seen in Treasury yields.

Given that fiscal deficit position of Sri Lanka is higher than the regional peer economies such as Bangladesh, Vietnam and Pakistan which are offering higher Treasury yields compared to Sri Lanka, it can be deduced that Sri Lanka’s Treasury yields in the secondary market may slightly adjust upwards in the range of 40-50 basis points in the medium term.

Further, the policy rate cut in December 2012 was also assisted by monetary policy changes that took shape in regional economies. Bangladesh, Vietnam and Pakistan cut rates in early December 2012 with the aim of reviving ailing output growth. This in turn provided the external leeway necessary for local authorities to cut domestic policy rates while simultaneously holding treasury yields close to regional levels amidst the sharp decrease in domestic Treasury yields.  On the domestic front, the fall in treasury yields despite rising trend in inflation was further enabled by the tight tax and tariff policy measures aimed at curtailing the less productive flow of imports. This tightening of fiscal policy from the side of Government revenue provided space for monetary aggregates to ease without disturbing the equilibrium in balance of payments.

However, the fall in Treasury yields could well be temporary as the regional rates have shown an increasing trend during the last two weeks of trading, which may impact the foreign reserves of Sri Lanka if domestic rates are not allowed to adjust accordingly, given that foreign capital inflows to Government securities account for circa 30% of gross official reserves. This is to say that both internal and external factors and their interaction play a critical role in the determination of domestic interest rates. Hence, in this setting, we expect a marginal upward adjustment to Treasury yields followed by a stabilisation of rates in the medium term.

In this light, Sri Lanka’s stock trading activity is likely to gain a further boost in the medium term on account of the expected stabilisation of Treasury yields at current low levels which raise the prospects of equity investments.