Central Bank says recent bond yield volatility unwarranted

• Upward pressure seen on short-term bills and longer-term bond yields since February
• Investors now wondering whether currency cycle of low interest rates is over
• However, broader market lending rates continue to decline

The Central Bank rebuffed the recent uptick seen in Treasury yields, calling the development “unwarranted”, although the investors were beginning to wonder whether the current cycle of low interest rates is over, as inflation to raise its ugly head with the pickup in economic activities with the easing of pandemic-related disruptions. 

There was upward pressure seen on the short-term bills and longer-term bond yields since February, which said to have been caused by the slippage in the foreign reserves and “the lack of clarity among market participants with the current economic condition”, according to First Capital Holdings. 

The Treasury bill yields in the secondary market climbed 10 basis points (bps), as the Central Bank relaxed the yield caps during the primary auctions while the yield caps for three-month and six-month securities were absent since the second auction for February. 

Meanwhile, the secondary bond market yields rose by between 25 to 50 bps, leaving the investors ponder whether the current cycle of lowering interest rates have bottomed out.
However, the broader market lending rates are still on the decline, as the prime lending rate touched a fresh low last week. 

“However, certain market interest rates such as yields on government securities have shown unwarranted volatility recently. They are not in line with the current monetary policy stance or the monetary policy expectations,” said Central Bank Director Economic Research Dr. Chandranath Amarasekara.  

The rising treasury yields is a global phenomenon, as the yields in the United States treasuries also rose on inflation expectations, as the economy gathers momentum with the declining COVID cases and the faster roll out of vaccines in the West. 

But the yields moderated towards the end of the month after the US Fed indicted that they have no intention of taking their foot off the paddle, which adds more monetary stimulus to support the economy. 

Commenting on the Sri Lankan context, rating agency ICRA Lanka said, “It is unclear whether pressure for treasury yields to go up is triggered by inflation expectations or the prospects of economic recovery or both.” 

The investors tend to shift their moneys to safe havens such as treasury bonds when there are signs of inflation picking up, as they get a guaranteed return from government securities when there is economic uncertainty over the prices. The more the investors flock to treasuries, the higher the yields go, as the bond prices and the yields are inversely related.  

Colombo consumer inflation rose by 3.3 percent in February, up from 3.0 percent in January 2021. 

Central Bank Governor Dr. W.D. Lakshman also recently expressed similar sentiments on bond yields’ behaviour. 

“We have already maintained rates at particular level through directions issued prior to auctions. We will continue with that. And hope that things will continue as in the past,” he said. 

When pressed as to what the Central Bank aims to do to keep the situation under control, he said, “We work as things demand but guided yields would be the continuous policy.”

The volatility in bond yields largely receded towards the February-end and through March, as the Central Bank doubled down on its commitment to maintain the dovish monetary policy and on the news of the People’s Bank of China approving the US $ 1.5 billion currency swap facility for Sri Lanka.