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What Is the Expected Behaviour of the Mozambican Public Debt Yield Curve in 2024?

What Is the Expected Behaviour of the Mozambican Public Debt Yield Curve in 2024?

  • Nilza Tenguice & Yara Soto • Global Markets Analysts

A yield curve is a graphical representation that shows the relationship between the yields of securities with the same credit quality and different maturities. In other words, it illustrates the yield expected by an investor when lending money for a specific period. This curve is widely used in the financial market as an economic analysis and forecasting tool, allowing investors to assess their expectations of future interest rates compared to current market rates.

The yield curve can have different slopes, which can be justified by a number of theories, namely: the expectations theory, the market segmentation theory and the liquidity preference theory.

The Expectations theory considers that the shape of the yield curve over maturities reveals the market’s rate expectations for those maturities. In this way, long-term interest rates are determined by the current level and expectations of the evolution of short-term interest rates, and can therefore be used to estimate future short-term interest rates.

The theory of market segmentation assumes that there is no direct relationship between the interest rates that prevail in the short-, medium- and long-term markets. Investors have well-defined preferences regarding the maturity of the securities they want to buy based on their profile. Thus, the sellers and buyers that make up the short-term bond market have different characteristics and motivations from the sellers and buyers of medium- and long-term bonds. For example, insurance companies usually opt for long-term bonds, while banks usually opt for short-term bonds.

The theory of liquidity preference suggests that economic agents have a natural tendency to favour more liquid securities and assets. The aim of this theory is to establish a risk premium for long-term investments that compensates for the loss of liquidity in the short term. Therefore, short-term yields should be lower than long-term yields. Taking the above theories into account, the yield curve can be presented in three main formats, listed below.

In the last four months of 2023, the debt yield curve was characterised by lower long-term interest rates than short-term rates

The normal yield curve is the most common in most economies, representing a stable economic scenario, which historically indicates the start of an expansionary economic period, where long-term interest rates are higher than short-term rates. In this sense, the market believes that short-term interest rates will rise in the future, as it could indicate accelerated growth in the economy, causing strong inflationary pressure. On the other hand, it could also mean that investors are considering government bonds to be riskier, thus demanding a higher risk premium.

The flat yield curve assumes that yields on longer-term bonds are similar to yields on shorter-term bonds. This pattern can indicate uncertainty about the future of the economy, as investors don’t have a clear view of future interest rates.

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Finally, the inverted yield curve, represented by long-term interest rates being lower than short-term interest rates, occurs when the market expects short-term interest rates to fall in the future, which may indicate an economic contraction that will result in inflation slowing down and the economy falling into recession. The central bank, keen to get the economy back on its feet and out of recession, forces interest rates down. With this expectation of a reduction, investors step up their purchases of long-term bonds to secure good rates before the reduction. And this demand provides money for the public coffers to act against the recession.

As explained throughout the article, the standard shape of the yield curve is positively inclined, where interest rates on short-term bonds are lower than long-term interest rates. However, due to the acceleration of inflation and the increase in interest rates by central banks in most of the world’s economies, it has been observed that the yield curves in the main global economies have been inverted since November 2022, thus signalling the start of a global recession or a cycle of expansionary monetary policy. As an example, on 7 February this year the yield on the 2-year and 10-year US government bonds was 4.402% and 4.104% respectively, giving a negative spread of -29.8 basis points (bp).

Domestically, in the last four months of 2023, the debt yield curve was inverted, characterised by long-term interest rates being lower than short-term rates. For example, the average 10-year yield was 16.00%, while the average 1-year yield was 18.50%. However, since the first auction in 2024, long-term interest rates have once again been higher than short-term interest rates, making the yield curve normal, with the 10-year standing at around 20.00% and the 1-year at 18.00%.

The post-pandemic increase in inflation, which worsened in mid-2022 when it exceeded one digit, led the Bank of Mozambique to increase reference rates in order to control it. Since April last year, inflation has been below single-digit levels, leading the Monetary Policy Committee (CPMO) to decide, at its last ordinary session, to lower the reference interest rates by 75 bp. Given the current economic climate, coupled with the consolidation of the medium-term outlook for inflation to remain in single digits, it is expected that there will be a gradual fall in interest rates in the near future, which could result in a downward shift of the current yield curve in short-term interest rates.

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