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Favourable macroeconomic environment fuels stability in fixed income markets
published: Friday | December 29, 2006

The Bank of Jamaica exerted strong pressure on interest rates and impacted liquidity conditions with the pulling of two longer term open market instruments. - File

During 2006, the Bank of Jamaica (BOJ) has been successful in its efforts to reduce interest rates and maintain stability in the domestic market.

The BoJ's ability to lower interest rates amid the numerous challenges in the Jamaican economy was underpinned by the consistent decline in the rate of inflation throughout the year, coupled with the relative stability in the foreign exchange market.

The decline in inflation resulted mainly from a quick rebound in the agricultural sector, which began in the fourth quarter of 2005, subsequent to the devastating effects from the aftermath of four major hurricanes that year.

At the beginning of 2006, the domestic market grappled with the major fall-out in the construction industry due to the breach in quality standards at Caribbean Cement Company.

However, despite the importation of cement the markets remained intact helped by the stability in the foreign exchange market evidenced by the Jamaican dollar's (JMD) depreciation of 2.2 per cent versus the USD by half-year 2006.

In addition, the 12-month inflation rate trended downwards consistently throughout the year (see CPI graph), despite the unparalleled increases in world oil prices, giving the BOJ a greater window of opportunity to lower interest rates.


At the beginning of the second quarter, BoJ effected the first adjustment to interest rates on its open market instruments for the year, after leaving rates unchanged for 10 months.

The central bank withdrew the long-term instruments from the market on April 18 - its 270-day and 365-day tenors.

It's action was classified by some analysts as an alternative to a reduction in interest rates.

Some investors thought the withdrawals would be short-lived, but the instruments have not been returned to the market to date.

Consequently, the market is still trying to decipher the BoJ's ultimate objective regarding the long-term tenors.

During the year, the BoJ has received continued support in its target of lowering interest rates, driven largely by the consistent good performance in the agricultural sector (the food and drink category accounts for a major section of the consumer price index).

As a result, the central bank became more sanguine regarding the economic outlook and particularly in relation to the achievement of a single-digit rate of inflation for the fiscal year 2006/07.


Subsequent to the BOJ's adjustment of its open market instruments in April, the market saw three additional interest rate reductions on all remaining tenors of 30 days through 180 days, on May 18, September 1, and September 22.

Up to September, there has been a reduction in rates by 65 and 70 basis points on the respective tenors year-to-date.

Since then, the BoJ has made another adjustment of 30 basis points across its remaining five tenors, pushing rates within a range of 11.95 per cent to 12 per cent.

As time progressed, with investors fully absorbing the fact that there would be a limited offering of instruments, the market experienced strong demand for the 180-day BoJ repos, driven mainly by the removal of long-term instruments.

This resulted in the high levels of liquidity for the BoJ COSH maturities during October through to December from the strong demand, which commenced in April.

Notably, the build up of high levels of liquidity in the JMD fixed income market provided even more leverage for the BoJ to lower interest rates (see BoJ Maturities graph showing liquidity versus movements in the 180-day Treasury Bill average yield and the 180-day repo rate).


Greater stability prevailed in the market despite the lower rates in the JMD fixed income market during the second half of the year, helped mainly by the non-active hurricane season coupled with the sharp decline in oil prices.

World-oil prices fell to a low of US$56.74 per barrrel in October, after the record high of US$78.40 in July.

This resulted in a decline in rate of inflation by 0.1 per cent for the month of October and brought greater justification to the actions of the BoJ.

With the BoJ garnering increased credibility from the market, traders responded by aggressively seeking other alternatives to increase the performance of their investment portfolios.

The declines in interest rates translated to lower yielding GoJ debt instruments throughout the year.

As a result, there was strong demand for variable rate instruments as well as short-term fixed rate securities with attractive yields, as these securities provide higher than average market returns with the downtrend in interest rates. Of note, the market has seen a limited offering of instruments due in part to the reduction in the total domestic loans tabled for the budgetary requirements of FY 2006/07 in comparison with FY 2005/06.

With limited offering of instruments coupled with the high levels of liquidity and the continued relative stability in the markets, traders have not ruled out another round of interest rate reduction by the Bank of Jamaica in the near-term. Traders inevitably have adjusted to the low interest rate environment and have considerably increased their trading activity in the secondary market in an effort to earn higher yields.


The U.S. Dollar (USD) fixed income market saw the narrowing of interest rate spreads between GoJ USD instruments and U.S. treasuries during the first half of 2006, on the heels of lower interest rates in Jamaica and rising rates in the United States.

As a result, the local market saw relatively stable interest rates hovering within a band of 6.0 per cent and 6.5 per cent for 30-day repo rates.

The overnight rates ranged between an average 5.25 per cent and 5.5 per cent.

However, despite the convergence between the local USD repo rates and the Federal funds rate, the market experienced modest volatility against the background of a stable macro-environment in the domestic market.

During the second-half of the year the USD fixed income market was generally characterised by, low liquidity levels, and low-to-moderate market activity.

Further there was also a limited offering of instruments throughout the year.

In October 2006, the GoJ issued a six-year fixed rate 7.5 per cent USD denominated local bond due 2012 with an offer amount of $65 million.

This instrument received a fair market response at a total intake of $59 million.

During the fourth quarter of 2006, the 30-day repo rates have traded an average 6.0 per cent and 6.25 per cent while overnight rates remained within the 5.0 per cent and 5.5 per cent band, as the market continued to experience low-to-moderate activity.


The fact that the majority of the Jamaican global bonds are held domestically, the downtrend in interest rates coupled with the stable market conditions contributed significantly to the creditable performance of the bonds over the past 12 months.

During the first quarter of the year, the global bond market was generally positive despite a brief downturn in prices during the month of February, which is due in part to profit taking.

One of the major highlights was the GOJ's success in issuing a USD denominated eurobond in the international capital markets with a tenor of 30-years the first in Jamaica's history underscoring the high level of confidence by overseas investors in Jamaica's long-term outlook.

The GOJ received an extraordinary response for the 8.5 per cent US$250 million eurobond 2036, as the offer was oversubscribed by US$150 million within hours after the open.

Over the period November 2005-November 2006, the global bonds registered creditable price increases particularly on the long-term bonds, such as the USD 22's, 17's and 25's which increased by 8.0 per cent, 9.0 per cent and 12 per cent, respectively.

The overall good performance during the period resulted from the stability in the local market, underpinned by the downtrend in inflation rates and interest rates as well as the stability in the foreign exchange market. Another contributor to the performance of the bond market was the 'Stable' outlook for Jamaica's debt from the international rating agencies during the year.


Notably, the bond market saw strong demand throughout 2006, from overseas investors and hedge fund managers. The demand has signaled some level of correlation - albeit at miniscule rate - between US treasuries and emerging market debt.

As overseas investors responded to movements in the federal funds rate, this oftentimes impacted their demand for emerging market debt.

This has resulted in the bond market seeing an increase in demand from overseas investors and hedge fund managers particularly in recent months as the Federal Reserve has held interest rates unchanged since June 2006 after its spate of 17 consecutive interest rate increases.

The government has maintained tight fiscal discipline and with the current stability in the domestic market coupled with the downtrend in interest rates the bond should not experience any major volatility outside of any external shocks or major political change.

Produced by the Wealth Management Unit of the Bank of Nova Scotia Jamaica Limited.

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