Financial analysis: Short-term yields approach 2-year low

There was an evident change in investment appetite by retail and corporate investors in Malta for short-term financial market instruments following the surge in interest rates in the euro area since the second half of 2022 compared to the previous decade of much lower yields.

With most local retail banks offering very low interest rates on savings and fixed deposits, participation in Malta Government Treasury Bill (T-Bill) auctions and short-dated Malta Government Stocks (MGSs) became an attractive alternative, with yields at times exceeding 3%.

In 2023, the weekly average nominal amount tendered for in the 91-day T-Bill auction stood at close to €200 million, but this fell to around €80m in 2024 since the average weekly accepted amounts during 2023 were at just €30m.

As such, last year most tenders were not accepted, with investors having to consider other investment alternatives, including short-term bonds in international financial markets.

Furthermore, the combination of the strong demand for T-Bills by the investing public together with the Treasury Department’s frequent changes in financing requirements resulted in substantial volatility of the weighted-average accepted yield on T-Bills.

For example, outstanding T-Bills more than doubled to €735 million as at last week, compared to €350m in mid-October 2024 following the most recent issuance of MGSs. This may also have contributed to the sharp volatility in accepted bids during the past few months.

Furthermore, since the European Central Bank (ECB) started reducing its interest rates as from June 2024, banks that take part in the weekly auction are likely to be satisfied with lower yields since their idle funds with the Central Bank of Malta (CBM) are now generating lower yields compared to when the ECB deposit rate stood at a multi-year high of 4%. The current ECB deposit facility rate stands at 2.75%, following five reductions of 25 basis points each since June 2024.

There are clear indications that further interest rate declines will take place across the euro area in the weeks and months ahead

The fall in interest rates can also be observed in the Euro Interbank Offered Rate (Euribor), which is typically also used as a benchmark reference for variable-rate loans. This week, the 3-month Euribor reached a two-year low of 2.52%, reflecting the easing of monetary conditions in the euro area in line with the latest ECB policy decisions.

Lower interest rates can also be noted from the corresponding bid prices for MGSs. The bids by CBM for all MGS issues maturing in the next five years are below 3%, which contrasts with bids from two years ago where the yields-to-maturity (YTM) on short-dated MGS were practically all above 3%.

The shift towards lower yields for short-term instruments could also be observed in the 5-year MGS that was on offer this week, namely the 3.00% MGS 2030 (IV) at a price of €101 for every €100 nominal, giving a YTM of 2.8082% per annum. For comparative purposes, the 5-year MGS offered in February 2023 had a corresponding yield of 3.24%, while the 5-year MGS offered in February last year yielded 3.15%.

In this context, investors should keep in mind the reinvestment risk when buying short-term instruments in a declining interest rate environment. In simple terms, one needs to consider what the prevailing yield would be when the short-term instrument is due for redemption and the proceeds would then need to be reinvested. As such, if an investor is looking for longer-term income, one needs to consider securities with a longer maturity that could offer better yields and a more stable income.

These changes in interest rates are also important for investors in local equities as they also have implications on the fundamentals of companies. In particular, when looking at the financial position of banks, one need to assess how are they positioned to mitigate the effect of lower short-term yields.

In recent reporting periods, Bank of Valletta plc had explained in extensive detail how it is optimising its balance sheet to enhance financial stability and performance by shifting cash and short-term funds into a Treasury portfolio made up of longer-term investment-grade instruments.

Another consideration for equity investors would be to assess the opportunities for companies that had borrowings impacted by the surge in interest rates over the past two years but may have prospects to benefit from lower finance costs in the years ahead.

Notwithstanding the ECB’s consistent reduction in interest rates since June 2024, there are clear indications that further interest rate declines will take place across the euro area in the weeks and months ahead. This will likely lead to continued changes across various asset classes that investors need to keep monitoring to optimise their investment portfolios in line with their objectives.

Jonathan Falzon is a research analyst at Rizzo, Farrugia & Co (Stockbrokers) Ltd.

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