EA ‘bond market is a free lunch’

Bond investors in East Africa yearn for sales of longer-term government paper to secure high yields and benefit from capital gains spurred by rate cuts seen later this year.

Yields on government securities in Kenya, Tanzania and Uganda surged last week as inflation and benchmark interest rates rocketed, and governments struggled to plug budget deficits.

With the exception of Tanzania, regional inflation started easing at the end of last year, helped by aggressive monetary tightening and improved food supplies after a drought.

Analysts said with inflation likely to continue falling, benchmark lending rates in Uganda already on the way down and likely to be cut in Kenya, longer-term bonds were attractive.

Aly Khan Satchu, a Nairobi-based independent economist, said the market was expecting longer-term bonds to be sold as governments seek to raise more funds after demand at many Treasury bill sales fell short at the end of last year.

"Inflation rates have crossed their cycle highs across the region and long-term bonds in Uganda and Kenya are an outrageous buy," Satchu said. "The fixed income market is a free lunch."

"The recent tempering of the inflation rate coupled with a Bundesbank ahead-of-the-curve monetary policy tells me that we are in fact done here in Uganda and that extending duration in the Uganda bond market is a no-brainer," he said.

Duration is a measure of how long it takes for the cash flow from the security to be received. The longer the duration, the more the bond price will rise for an equivalent yield fall.

Demand for government securities in the region has jumped this year due to offshore investors enticed by high yields and commercial banks hedging against loan defaults after lending rates rocketed last year.

CENTRAL BANK

On Feburary 1, the Bank of Uganda (BoU) sold five-year Treasury bonds at an auction with a bid-to-cover ratio of 5.3, indicating increased appetite for longer-duration paper.

While the yield came in at a record 17.96 per cent, traders had expected it to top 20 per cent.

Uganda last sold five-year paper in September when the central bank’s benchmark lending rate was 16 per cent. The central bank cut the rate to 22 per cent from 23 per cent on February 1, the day of the five-year auction.

"With yields declining it will become increasingly attractive to lengthen duration, and it is likely that the BOU will increasingly offer longer-dated paper in coming months, to keep foreign capital inflows strong," Standard Bank said.

Traders in Kenya also expect longer-term paper to be offered at auction in February.

"Even the roughly 18 per cent weighted average yield for the five-year bond is likely to be profitable, with five-year yields probably falling to around 13 percent by year-end," said Phumelele Mbiyo, head of macroeconomic research at Stanbic Bank.

Yield on most short-dated paper are around 20 per cent but with central banks starting easing cycles, they are likely to drop.

While Kenya left its benchmark rate at 18 per cent last week, its next move is expected to be down. Bids received at three Treasury bill auctions last week came to KSh20.5 billion, more than double the KSh10 billion on offer.

"Investors know that soon this level of yields will be gone. So they’re really rushing to lock in their investments while the high yields last," said Rodgers Lutaaya, a dealer at Bank of Africa in Uganda.

HIGH INFLATION

In Tanzania, inflation inched up to 19.8 per cent in December but traders said it may have peaked and there was a huge domestic demand for treasury bills this week. Capital curbs prevent foreigners from trading in local government bonds.

The Bank of Tanzania received bids worth Tsh440 billion for the 100 billion of bills on offer, pushing the yield on 364-day bills down more than three percentage points to 15.3 per cent.

"Many people don’t think these high yields will be sustained for long. We think they might return to the usual single-digit levels," said Frank Ndugulile, a trader at CRDB bank in Dar es Salaam.

"Yields have not been this high since 2007/2008."

—Reuters