Kenya: Prospects of interest rate cap repeal to elevate appeal for lower duration bonds

Investors may enhance their exposure to lower duration bonds as the uncertain interest rate environment portends a big effect on bond       portfolios. Following the President’s recommendation to repeal the law capping interest rates, investors are priming themselves for the         possibility of higher interest rates.

Coupled with the government’s bigger debt load, given the under-performance in revenues, this should temporarily steepen the yield curve as longer dated yields rise faster than yields on short-term bonds.

The central bank will however remain cautious of any aggressive bidding on longer tenures in an effort to align the yield curve to its policy signals. To be sure, the central bank has suggested scope for monetary easing, which will be anchored on prospective fiscal tightening.

Meanwhile, the National Treasury has already made clear its intention to rationalize its budget estimates, by revising both its revenue and spending targets lower, through a supplementary budget to be tabled in Parliament sometime this year.

The budget deficit could narrow to about 5.10% of GDP in the financial year 2019/2020 from the 5.60% revised deficit indicated in the Budget Review Outlook Paper of September 2019.

The move towards fiscal prudence not only promotes a more sustainable consolidation path but it will as well help the government achieve its desired narrower budget deficit for the 2019/2020 fiscal cycle.

Should the cap be lifted, a decline in the sovereign’s appetite for local debt could blunt a significant uptick in interest rates. Moreover,  the extent to which excess funds in the market are directed towards private sector credit extension activities will as well determine the overall direction of interest rates.