Returns on Treasury bills and bonds have started increasing as investors seek higher compensation to cover rising inflation, setting the stage for higher borrowing costs for the government.
Interest on the 91-day has increased to 8.3865 percent from 7.4261 percent at the end of March, while returns on the 10-year bond are up to 9.5 percent from 8.85 percent on April 21.
The rising returns on government papers are prompting investors to start shifting assets from the Nairobi Securities Exchange (NSE), which has seen three-quarters of counters at the bourse record a drop in share prices.
The volatile environment has been marked by shocks from the Iran war, which has seen investors cut demand for equities in favour of assets viewed as less risky, like bonds and fixed deposits.
This has upended the market, with the equities market losing its two-year status as the top-performing asset class.
Overall, the Nairobi bourse has posted a drop of 1.3 percent in the month, in contrast to the double-digit gains it made in 2024 and last year. Average bank deposit rates were quoted at 6.86 percent.
The market shifts could derail the Treasury bid to borrow cheaply amid investors demanding higher returns as it prepares to tap nearly Sh1 trillion in net domestic borrowing from banks.
The weighted average rate for accepted yields in the most recent bond auctions has edged higher beyond the expectations of analysts, while investors have begun opting for the shorter-dated 91-day Treasury bill to avoid locking their money for long periods as interest rates move up.
Traded yields on bonds at the NSE are also going up, while prices have begun moving lower in tandem with the interest rates’ expectations.
The expectation for higher interest rates on government securities stems from a spike in inflation, a fallout from the US-Israel war on Iran and the resultant spike in global fuel prices.
“All indications are that interest rates may have bottomed out and could gradually trend upwards, amid heightened geopolitical uncertainties surrounding the US-Israel-Iran tensions and the resulting pressure on global energy prices,” said analysts at Sterling Capital, a local investment bank.
“Recent T-bill auctions support this view with the bulk of investors bidding for the 91-day Treasury bill, and accepted rates have been higher than in previous auctions.”
Higher returns
Interest rates on Treasury bills have moved higher since last month, with the yield on the 91-day, 182-day and 364-day Treasury bills rising to 8.3865, 8.2113 and 8.5881 percent, respectively, in the latest auction from 7.4261, 7.8292 and 8.2815 percent at the end of March.
Yields on the 91-day Treasury bill have risen the quickest in the period as investors aggressively bid for higher returns on the shortest-dated instrument to avoid locking in funds at lower rates.
Investor bids on the 91-day paper climbed to Sh15.8 billion last week from Sh7.3 billion previously, mirroring the perceived duration risks, while bids on the longer 182 and 364-day papers were lower at Sh8.3 billion and Sh5.7 billion, respectively.
This month’s switch bond results also signal the underlying interest rate reversal as the market-weighted average rate for accepted bids at 13.4116 surpassed analysts’ expectations, even as the return remained below the destination bond’s coupon rate of 13.444 percent.
“The CBK’s weighted average rate of accepted bids for FXD1/2021/20 was seven basis points above our predicted range averages. The auction outcome suggests heightened investor expectations of rising interest rates, prompting aggressive bidding,” added Sterling Capital analysts.
Results from the reopened 15 and 20-year bonds also illustrate an uptick in yields as the papers sold only for a slight premium despite carrying notable accrued interest.
The re-opened 15-year paper posted a weighted average rate of 12.97 against a 12.34 percent coupon, while the price was only a slight premium at Sh101.1 despite carrying an accrued interest of Sh4.2715.
The 20-year reopened bond fetched a return of 13.74 percent against a 13.44 percent coupon and had a slight Sh101.9 premium price despite carrying accrued interest at Sh3.8781.
This shows that the implied premium price from the accrued interest was greatly reduced at the bonds’ sale.
Traded bond yields at the Nairobi Securities Exchange (NSE) also reveal a turn in interest rates as the returns rise while prices drop.
The traded yield on FXD1/2016/10-year paper has grown to 9.5 percent as of May 21 from 8.85 percent on April 21, while the premium on IFB1/2024/8.5-year has been greatly reduced as the traded yield rises to 12.35 percent from 11.975 percent previously.
Churchill Ogutu, Head of Research at Capital A Investment Bank, says investors will likely cool off on secondary bond trades as prices retreat to offset the rising traded yields.
Bond yields usually have an inverse relationship with prices, where rising interest rates result in lower prices as investors shift their demand to future issuances, which would carry a higher return.
“The concern among investors is the expectation that interest rates begin to move higher. From a mark-to-market perspective, investors wouldn’t want to have their portfolio underwater,” he said.
