Kenya: Rate cap repeal boosts investor risk appetite

The month of October ended on a high as indications of a post-interest rate cap era improved investor risk appetite. Bank stocks rallied for the second consecutive week, rising by close to 26.00% on average as prospects of increased lending and profitability anchored investor sentiments.

Adjustments to the yield curve, as a result of a rate cap repeal, could take some time to filter through given opposing forces from both monetary and   fiscal policy. For one, the government is seeking to rationalize its budget estimates in an effort to reign in on unrealistic revenue targets as well as cut unnecessary spending.

This could enrich its path towards fiscal consolidation by narrowing the fiscal deficit to 5.10% of GDP compared to the reported projection of 5.60% of GDP in the Budget Review and Outlook Paper of September 2019. Lower sovereign borrowing appetite should avert crowding out the private sector as well as keep interest rate expectations fairly contained.

Meanwhile, the central bank may contemplate easing its policy rate during the November policy setting meeting aided by benign inflation (October = 4.95%) and the need to propel economic growth. Furthermore, prospects of fiscal tightening as well an improved transmission of policy following a rate cap repeal should anchor the accommodation.

The aforementioned may blunt a significant upward adjustment of the curve, at least in the near term. We therefore hold that investors will remain biased towards lower duration bonds in light of rising  interest rate expectations. Further, aggressive bidding on longer dated issues may result in a steepening of the yield curve as the interest rate spread widens.