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Bond yields to extend further surge; rate hike expectations for 2022E increased: FCR

In light of the weaker economic conditions, First Capital Research believes that the CBSL will maintain the momentum on tightening policy rates resulting in yields to further surge at an accelerated pace, and expect it to move further over upcoming months.

Sri Lanka's foreign reserves were recorded at USD 2.3Bn in Feb 22 and due to lack of expected foreign inflows, foreign reserves are expected to significantly deteriorate well ahead of the previous timelines.

Moreover, approximately USD 7.0Bn outstanding loan payments due for the next 12 months further kindle the situation.

Depleting foreign reserves, rising foreign currency debt repayment requirements, restricted market funding sources and recent adverse global developments, and surging commodity prices are projected to put more pressure on yields in 2022E.

In 1H 2022 the extremely weak economic indicators forced the Monetary Board to further tighten the monetary policy. In Jan 2022, First Capital Research expected 3 rate hikes for 2022E targeting a total of 150 bps.

"Under the worsening economic conditions, CBSL had to tighten 150 bps in two policy review meetings (In Jan - 22, 50 bps and in Mar - 22 100 bps) while Mar - 22 hike was a couple of months ahead of our expectations to balance the overall economy," First Capital Research said.

"Considering the significant deterioration in economic conditions, we increase our rate hike expectations to a total of 4 for 2022E from previous 3 while targeting 2 rate hikes 200 bps) in the 2H 2022E to combat the macro pressures."

2022 to be Bearish on Bonds: Yields of 1Yr, 5Yr, and 10Yr have moved beyond the upper bands in the base case scenario and may reach yields of worst-case scenario with no IMF or further foreign inflows.

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