Home' Trinidad and Tobago Guardian : March 1st 2018 Contents BG10 finance
Thursday, March 1, 2018
ates in the US are
on the rise. This
will give rise to
issues for T&T in
terms of how we
craft our monetary and fiscal pol-
The Treasury yield curve is a
measure of the difference between
the rates on short-term and long-
term debt issues by a government.
Under normal conditions this
curve is upward sloping to re-
flect the extra compensation
that an investor will want to lock
away their money. So the rate
on a shorter-term bond, say, two
years should be lower than a me-
dium term five-year bond and this
should be lower than the rate on a
During the fourth quarter of
2017 the US Treasury yield curve
was flattening as the US Fed-
eral Reserve continued to raise
its short-term interest rates but
longer term interest rates most
notably the 10-year US Treasury
bond did not move in lock step.
The US 10-year bond started
the year at a yield of 2.40 per cent
while the 30-year bond was at 2.74
per cent. For a number of years
the US 10-year did not go above
2.65 per cent and was often seen
trading at a low two per cent han-
What is taking place now rep-
resents a fundamental shift in the
interest rate dynamic. The US 10-
year bond has broken out of its
trading range and is trending to-
wards three per cent. It is likely to
get there despite the recent pull
back from last week.
Fundamentally the 10-year bond
should trade at the level of the rate
of nominal growth in gross domes-
tic product (GDP).
The recently introduced tax
measures in the US means that in
the short term at least, economic
growth is expected to pick up.
This creates a fundamental argu-
ment for the 10-year US Treasury
to land at three per cent trending
towards four per cent.
All in all this reflects a path to-
wards a normalised interest rate
environment, which is essentially
where markets need to be outside
of a time of crisis.
The US Federal Reserve has sig-
nalled this intent with the market
pricing in between three to four
25 basis point rate hikes over the
course of 2018.
The path to normalisation is
where things can quite possible
get very tricky. One of the lessons
from the 2008 financial crisis was
that when things stay out of line
for a long period of time, risk is
mispriced and imbalances begin
It was in 2001 with a mild US re-
cession, a dot com crash and a ter-
rorist event that the US cut interest
rates to then record levels. These
low rates were maintained for half
a decade leading to imbalances
in the financial markets, specifi-
cally related to the housing sector,
which eventually lead to a collapse
once rates began to rise again.
This time around we have seen
close to a decade of zero interest
rates and it is only over the past
year that the US Federal Reserve
has begun the process of normal-
That process involves two as-
The first was selling off assets or
allowing assets which it held on its
balance sheet to run off or mature.
This causes the size of the balance
sheet to shrink. It is similar to a
bank not replacing loans that are
paid down each year with new
loans. Less credit is being created.
The next step is what we have
just discussed which is the raising
of short-term interest rates and
the resulting effect that this will
have on the overall term structure
of interest rates.
In the short term the argument
is that the US Fed will not be rais-
ing rates if the economy was not
on sound footing and so at the in-
itial stages there is cause for opti-
mism. We are now getting to the
next phase where that growth rate
has to be proven and also be seen
to be sustainable.
Impact on T&T
What goes on in the US is going
to affect us in some way.
Post 2001 investors brought
money back to T&T and the Gov-
ernment took advantage of the
low interest rate environment to
cut rates and lower taxes. That
pushed our local stock market up
until it peaked in 2005.
Following the 2008 financial
crisis we had our version with the
collapse of CL Financial. Then the
rebound in the US housing market
saw significant outflows of US dol-
lars for portfolio investment pur-
poses, which has impacted our
level of currency reserves today.
Appreciate that about US$150
trillion denominated short-term
debt and derivatives in the emerg-
ing market space are tied to the
short-term US Treasury rate.
In addition note that changes to
the term structure of US rates is
going to affect global debt in some
way or another.
A change in interest rates in the
US directly affecting the yield on
debts outside the US is a first-order
effect. How market actors respond
to those changes are second order
effects and at this stage is depend-
ent on the specific circumstances
of each entity.
In T&T we have attempted to
hold interest rates steady. Under
the previous Governor of the Cen-
tral Bank of T&T there was an at-
tempt to front run the US Fed rate
hikes but since then the repo rate
has reflected a neutral stance de-
spite the signals from the US Fed.
We are at the stage now where
there is little disparity between US
and TT rates and so the incentive
to hold TT dollars over US dollars
is virtually non-existent.
Against this we have to fac-
tor in the decline in our foreign
currency reserve position from
US$9.4 billion to $8.3 billion at the
end of 2017.
It is my estimation, based on the
difference in credit rating between
the US and T&T, there should be
a 300-basis point spread between
the US and TT interest rates.
There is an argument that the
tighter fiscal stance by the Gov-
ernment, on account of reduced
revenues overall leads to tighter
conditions, so there is no need for
However, while this will hold
true for domestic conditions it
does not address the relative posi-
tion between US and TT rates.
The other reality is that low
rates also favours government’s
need to borrow to plug its budget
deficit. In addition, higher inter-
est rates could slow the rate of on-
shore economic activity, which is
critical at this time.
Add to that mix the considerable
amount of variable rate mortgages
that are in place where a rate in-
crease on top of less disposable
income can have significant con-
What should be clear is that the
TT economy has also developed
significant imbalances on account
of more than a decade of low inter-
est rates and government deficits.
Now the re-balancing act is
going to become even more diffi-
cult as the US Federal Reserve con-
tinues on its stated course.
Ian Narine can be contacted
via email at firstname.lastname@example.org
T&T’s interest rate challenge
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