Karachi, September 20, 2022 (PPI-OT): Dissecting the negative yield curve

Pakistan’s yield curve, which was upward sloping till Oct-2021, turned flattish by Apr-2022, moving towards an inversion since then, widening the most in at least two decades. While inverted yield curves are relatively short-lived, the last time Pakistan witnessed the same lasted for nine months, in 2019-2020.

This is not a different phenomenon when compared to other countries owing to global inflation pressures and recession fears. At present, more than 15 countries have an inverted yield curve, out of which most are A or higher rated countries by S and P.

As lower economic growth also correlates with inverted curves, Pakistan has begun to witness early signs of lower large-scale growth. This could further be dampened by impacts from the flash floods, significantly reducing FY23E GDP growth.

Inverted yield curve expands most in at least 2 decades

Pakistan’s yield curve, which was upward sloping till Oct-2021, turned flattish by Apr-2022, moving towards an inversion since then. The spread is not only reflecting a higher near-term inflation trend which is expected to normalize in the longer term, but has widened the most in at least two decades.

A similar case is also reflected in Pakistan’s international bond yields where earlier maturing bonds (2022/24) are trading at yields close to 45%, while bonds maturing by 2027 and 2031 trade at yields of 20% – 23%. While inverted yield curves are relatively short-lived, the last time Pakistan witnessed the same lasted for nine months, in 2019-2020. This was also when other countries had last witnessed yield-curve inversion, albeit, for varying time intervals.

Global landscape depicts a similar picture

This is not a different phenomenon when compared to other countries owing to global inflation pressures and recession fears. At present, more than 15 countries have an inverted yield curve, out of which most are A or higher rated countries by S and P. A similar assumption plays in the global inflation readings, pumped up by higher commodity prices at present, and expected to recede after a couple of quarters.

Lower economic growth correlates with inverted curve

To address the higher near-term inflation Pakistan has so far raised the Policy Rates by 800bp raising it to 15% in one year. This has also been accompanied by ~30% PKR depreciation, which still continues; we observe a similar pattern in regional currencies as well over strengthening dollar index and macro headwinds over pressure on external account of net importing countries.

For Pakistan, the sharp monetary tightening has begun to reflect in cooling off the overheated economy, reducing demand in various segments across the board. With decline in auto, POL products, cement and fertilizer sales so far, we do not rule out LSM growth limiting to low single-digit in the coming months.

This also coincides with an inverted yield curve also signalling depressed economic demand, also reflected in the graph on the right. This fix can also be prolonged for some more months owing to aftermath impacts of the floods on various segment productions. While land soaked in water is expected to delay goods distribution to many parts of the country, lower availability of land and damage from floods is also expected to dampen the agri output this year. We present a brief scenario analysis on the impact of lower LSM and agri growth on GDP growth for FY23, where our expected GDP growth falls from 4.2% to 3.2%.