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Fixed income: slow and steady

Today, we at Bourse take a look at the local financial system with respect to inflation and liquidity, as well as a brief recap of international emerging fixed income markets. We review the trends observed in the first quarter of 2014 and consider investor implications.

Inflation
According to data from the Central Statistical Office, headline inflation —as measured by the Retail Price Index —increased to 3.9 per cent year on year (y-o-y) in February, from 2.9 per cent in January and 5.6 per cent in December 2013.
This compares favourably with the rate which stood at 6.9 per cent in February 2013, suggesting prices are increasing at a slower rate on an annual basis.
Food inflation—the main driver of headline inflation—sharply decelerated to 5.2 per cent in February from 10.2 per cent in December 2013. This constitutes an improvement from January 2013, when food inflation stood at 13.8 per cent. Core inflation (inflation ex-food prices) increased to 2.7 per cent in February 2014. Figure 1 illustrates inflation rate changes over the past 12 months.

Liquidity
Based on observable data, liquidity levels in the local financial system remain high relative to past periods. According to the Central Bank of Trinidad and Tobago (CBTT), commercial banks’ excess reserves increased to a daily average of $7.1 billion over the month of March 2014. This represents a $400 million increase from the end of February 2014, when the level was around $6.7 billion. There was slight increase in liquidity despite open market operations and foreign exchange trade sales to authorised dealers, which resulted in withdrawals of $2.1 billion between January to March 2014.
The CBTT is confident that due to the approval of increased borrowing limits for the state, they will be more equipped to remove the excess liquidity from the banking system. Notwithstanding excess liquidity levels, the Bank has reiterated its stance to provide an accommodative environment against the backdrop of relatively stable inflation and tepid growth and maintained the Repo rate at 2.75 per cent.
Figure 2 illustrates liquidity levels over the past 3 years while Figure 3 reflects repo rates, and prime lending rates for the same period.
Access to foreign currency, particularly USD, remains an issue as the USD:TTD exchange rate continues to gradually climb. For the first quarter of the year, purchases of foreign exchange by authorised dealers from the public were USD$691 million and sales were USD$872 million.
The CBTT did intervene in the market, with USD$50 million being auctioned to local commercial banks. US dollar holdings are expected to increase due to energy based companies’ preparation to meet their quarterly tax obligations through the exchange of currency. Figure 3 shows the annual movement of the TT dollar against the US dollar for a 5-year period, as well as year-to-date as at April 2014.


Global Capital
Markets
Despite a rocky start to the year, most global asset categories posted modest returns during Q1 2014.
Equity markets in the US and other developed economies registered minute gains after significant advances in 2013, while bond markets benefited from a slight decline in interest rates.
When compared to worldwide equities gaining 1.6 per cent as at April 30th 2014, investment grade bonds on average generated 2.9 per cent returns.
Figure 4 illustrates the different returns of indices, showing the bond market’s outperformance over the equity markets for the first quarter of 2014. Janet Yellen’s appointment as the new Federal Reserve Chairman has left outgoing Chairman Bernanke’s stimulus policies intact.
The Fed has continued to foster an accommodative interest rate environment, while scaling back on the its quantitative easing programme. All these events have been viewed favourably by global bond markets, supporting bond prices.

Recommendations
Being able to take advantage of new investment opportunities and relatively new foreign markets is an important objective of any investor. For more risk-averse investors, TTD fixed income investment opportunities are likely to remain limited throughout 2014. Investors continue to find more attractive, risk-adjusted yields on fixed income beyond our shores. Investment grade, USD emerging market corporate bonds in the 7 to 10 year space offer investors significant yield pickup—in some cases more than 2 per cent—over similarly tenured local bonds, which return around 2.5 per cent. In addition to the much publicised BRIC’s (Brazil, Russia, India and China), international investment opportunities are to be found in many other Emerging markets across Asia, Latin America and Europe.
Investors who are able to access US$ can benefit from higher returns, as well as asset and currency diversification. While bonds are typically less risky investments than equities, they are not entirely risk free.
With an incredibly diverse fixed income menu to choose from, investors would be well-served to consult with their preferred investment professionals before making any investment decisions.
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