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I nterest rates: Why are yields rising and a look ahead

Since the National Debt Exchange (NDX) was announced

in February 2013, there has been a notable rise in risk

premium demanded by the market. The average yield on the

6-month Treasury bill (T-bill) has increased 69 basis points

from a low of 5.75% while yield on the 3-month T-bill is

112 basis points higher relative to the low of 5.50%

registered in February. Likewise, yields in the secondary

market reflected a marked increase on the lower to middle

portion of the local Jamaican dollar yield curve for theperiod.

The upward adjustment being observed in market-

determined interest rates is a call for concern given that the

new variable rate NDX bonds are re-priced against the 90-

day T-bill rate. To put this into perspective, the variable rate

portion of the debt represents approximately 33.6%

(J$339.2Bn) of the total domestic debt stock, therefore a 1%

rise in interest rates would result in the countrys debt stock

increasing by about J$3.4 billion or 0.25 percentage points

of GDP.

The trend reversal in yields reflects a number of technical

market factors. First, some GOJ US dollar denominated

local bonds currently offer slightly better returns than

similar GOJ local currency bonds, warranting higher yields

on Jamaican dollar denominated instruments to correct for

the misalignment in returns. Second, short-term rates are

rising due to tight market liquidity conditions occasioned by

a shortage of short-term instruments, an outcome of the

NDX which adversely affected the ratio of short-term assetsrelative to longer maturities.

Consequent to the above mentioned factors, the market has

faced some amount of selling pressure as financial

institutions move to relieve their balance sheet of longer

maturity bonds in an attempt to improve their short-term

assets to long-term assets ratio while simultaneously

reducing duration risks. Given an absence of buyers for

these long bonds, the central bank (BOJ) could purchase

Figure 1: Interest Rates

Figure 2: Local Jamaican Dollar Yield Curve

Figure 3: Headline and Core Inflation Measures

5.0%

5.5%

6.0%

6.5%

7.0%

7.5%

8.0%

May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13

Yield(%)

180-day T-Bill 90-day T-Bill

Source: BOJ, SIJL

Negative investor

sentiments fueled

by lack of IMF

agreement

Occasioned by the

NDX

5%

6%

7%

8%

9%

10%

11%

12%

13%

30dys

90dys

180dys

270dys

1 yr 2yrs

3yrs

4yrs

5yrs

6yrs

9yrs

10yrs

14yrs

15yrs

29yrs

35yrs

Yieldtomaturity(%)

Time to Maturity

JA$ Local Yield Curve

28-Feb-13 24-May-13Source: SIJL, PSOJ

2.0%

4.0%

6.0%

8.0%

10.0%

Apr-12 Jul-12 Oct-12 Jan-13 Apr-13

Point-to-Point

Inflation

PTP Headline PTP ex agri & fuel (Core Inflation)

Source: STATIN, SIJL

Despite recent uptick in

rates, real return remains

negative due to relatively

higher inflation.

Economic Update JamaicaPrepared by: Damain Powell

Financial Analyst

damain.powell@scotiabank.com

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June 14, 2013 Page 2

these instruments from the market and issue shorter ones

in an attempt to ease the liquidity squeeze. However, BOJ

has been reluctant to take this route as there is also the

possibility of excess Jamaican dollars flowing to the

foreign exchange market adding pressure to the localdollar.

Looking further, given the shortage of short-term assets

and BOJs reluctance to supply the market with these

instruments, the current overhang to sell long-term bonds

could persist, posing material upside risk to interest rates.

Furthermore, for this fiscal year, the government is looking

to amortize approximately J$76.4Bn worth of domestic

debt of which 30% or J$23.0Bn is local currency.

To finance this portion, J$13.8Bn will be sourced from thedomestic market while the remaining J$9.2Bn will come

from external sources, flowing to the market in the form of

excess liquidity. This will have a negligible effect on

easing the current market tightness. We have therefore

revised our outlook for market-determined interest rates to

remain sticky-up in thenear term. Interest payments on

new NDX notes expected in each of the next three quarters

of the fiscal year is however likely to temper considerable

increases in rates.

Figure 4: Real Interest Rate

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

May-09 May-10 May-11 May-12 May-13

6 month Point-to-Point Real After Tax Return

(180-day T-bill less inflation)

Source: SJIL, STATIN, BOJ

Negative real

returns persist

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Research Disclaimer:

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