As Africa’s copper producer begins its descent into 2022 one thing for sure most market players are bullish about is the sovereign outlook propelled by an International Monetary Fund (IMF) endorsement, change in political regime that saw Hakainde Hichilema ascend to presidency that fueled a sentiment boost and above all, a healthy metal outlook as red metal prices remain buoyant at decade highs on the London Metal Exchange (LME). Zambia is finishing the year strong with a 290 basis points ebb in inflation to 16.4% as food prices continue to decline significantly. This adds to an array of positives ranging from an expansion in private sector activity to 51.8 as measured by Markit Economics Purchasing Managers Index (PMI) to positive quarterly growth as the economy fully shrugs off COVID effects fully.
SHORT TERM BONDS ARE NOW ATTRACTIVE
Despite a falling yield curve, treasury bill returns remain underwater as inflation was still fairly high in the double digits whose easing trajectory was much slower than the ‘post election’ yield curve rally. The biggest concern for local investors has been negative real returns making government securities unattractive. Local investors will always show concern for such as their purchasing power is eroded by inflation while foreign investors will be more focused on yields both in local and foreign currency terms factoring in exchange rate risk.
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Until 2021 year end inflation sagged 290 bps to 16.4%, premiums above consumer price index (CPI) for 2 and 3 year bond yields turned positive overnight making these tenors join the list of attractive bonds. However the entire short term Kwacha demand curve remains under water (below inflation).
THE SHORT END IS SIGNALING INTEREST RATE BEARS
The last treasury bill auction of the year 2021 saw the 9 month yields edge higher 305 bps to 12.9999% while the penultimate sale of the year ‘curtain raised’ bears such as in the 1 year when it spiked 150 bps to 15.0%. These rate hikes were in the labyrinth of a falling rates when bond yields ebbed 55-115 bps in the last bond auction of 2021.
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The Bank of Zambia will seek to raise K6.6 billion a 53% increase in monthly government security offers for 1Q22 as they target raising funding for an ambitious 2022 budget. However with the suggested increase, interest rates could come under pressure as clearly the auction size increase will overcrowd the domestic credit markets. Other pressures will be inflation driven as petroleum energy price hikes and electricity yet to be implemented could force the yield curve to adjust higher to keep real yields and premiums positive. The fear around a bearish trajectory observed is the contagion to the long end which could reverse the rally seen over the last three months. A bearish rate environment could push term funding costs higher into 2022.
‘OMICRON’ INTENSITY WILL SHAPE GLOBAL MONETARY POLICY
Much of the interest rate direction will be shaped by indigenous market funding needs for a 2022 fiscal budget within a global environment that is still yet to address excess inflation in pandemic times that has emerging and frontier market assets, Kwacha paper inclusive, very attractive on account of positive real yields in both local and dollar terms. Currency risks will play a key role in the money market transfer mechanism as a projected stronger Kwacha will in part offset cost push inflationary effects while omicron intensity will determine global monetary policy which will point liquidity to higher yielding assets, likely in emerging markets. Zambias improved sovereign outlook post IMF Staff Level Agreement could see the Southern African nation amass Foreign Direct Investment (FDI) flows while higher metal prices will keep mineral royalties a healthy foreign exchange source for the central banks in its reserve build up program. Markets have already started to price in debt restructure targeted for 1H22.
The Kwacha Arbitrageur