The difference in the interest rates on long- and short-term bonds has narrowed significantly in the past month, raising prospects of a normal yield curve on government bonds.
A yield curve is considered ‘normal’ because the market usually expects more compensation for greater risk in longer-term investments.
In a normal yield curve, short-term debt instruments have a lower yield than long-term debt instruments of the same credit quality.
This means that the higher yields compensate for the increased risk normally involved in long-term ventures and the lower risks associated with short-term investments.
Interest rate spreads between the 2-year and 10-year bonds have closed to just 0.22 percent as of October 4-with the yield on the shorter-dated paper at 17.29 percent while the return on the 10-year bond stands at 17.07 percent.
The spread has closed from 1.626 percent a month ago when yields on the two papers stood at 18.526 percent and 16.9 percent respectively.
Yields on shorter-dated bonds have been higher than long-term papers, a scenario described as a yield curve inversion, reflecting short-term risks that saw investors expecting higher interest rates, forcing the government to pause the issuance of long-term bonds.
Short-term risks, including investor jitters surrounding the redemption of Kenya’s debut sovereign bond in June drove yields on government securities higher, forcing the Central Bank of Kenya (CBK) to pause issuing longer-term bonds to avoid paying a premium return for longer.
The yield usually reflects the return that investors can expect if they hold their bond until maturity and is a critical indicator of economic confidence and investor sentiment.
The fall in yields on the shorter-dated Treasury bills in the past two months has signaled a risk-off environment, marking the start of the normalisation of the yield curve as high interest rates on the securities ease.
Interest rates on the short-term bills and bonds are expected to drop further with CBK widely seen cutting its benchmark lending rate further, beginning at its October 8 meeting.
Government bond issuances however continue to feature re-opened papers which have a preset rate of return as the CBK seeks to keep a lid on government interest costs.
The CBK has only issued one new bond this year in February- a 10-year paper but set a rate of return at 16 percent to entice investors to long-term bonds while capping yields.
The government securities yield curve is determined from a selection of fixed interest rate bonds of FXDs, which excludes tax-free infrastructure bonds.
