Foreign investors are abandoning Kenya in search of higher returns in markets such as Uganda as yields in east Africa's largest economy tumble into single digits.
Yields on Kenyan debt are likely to stabilise below 10 per cent in the near future, with subscription rates at auctions declining as foreign investors seek higher yields elsewhere.
In recent weeks, yields on the short-end of the curve have tumbled during auctions as a build-up in liquidity from debt redemptions and expectations of lower inflation fed demand.
The Central Bank of Kenya is scheduled to auction 2 billion shillings ($23.4 million) of 182-day Treasury bills on Wednesday and 2 billion shillings of 91-day Treasury bills on Thursday.
During this week's auctions, the weighted average yield for 5-year bonds fell 200 basis points to 11.86 per cent, while 6-month paper shed just over 100 basis points to 10.92 per cent.
Rates on 3-month paper slipped into single digits for the first time since September, falling 20 basis points to 9.87 per cent.
"That was a correction and we may have come to an end," said Duncan Kinuthia, head of trading at Commercial Bank of Africa. "We may see some consolidation slightly below the 10 per cent mark for the T-bills."
Kinuthia said foreign investors, who have been active in the primary market this year, were leaving the Kenyan debt market to chase higher yields in other countries such as Uganda.
Traders said that the drop in yields, falling inflation and a fairly stable shilling pointed to a possible rate cut at the monetary policy committee's next meeting on June 5, which could prompt a rally in bond prices.
The central bank has held its benchmark rate at 18 per cent for five consecutive months, which has helped bring down inflation more than 6 percentage points to 13.1 per cent in April and stabilised the shilling.
"We'll continue to see a slower decline in the immediate short-end given the aggressive drops on the bills (yields)," said Alex Muiruri, a trader at Africa Alliance Investment Bank.
Yields on Ugandan short-term paper are set to remain in the high double digits next week as the market awaits inflation figures for May and the central bank's interest rate decision.
The Bank of Uganda will offer 120 billion shillings ($48 million) in 91-, 182- and 364-day Treasury bills, with yields expected to stay around the 18 to 20 per cent range.
The bank held its key lending rate at 21 per cent earlier this month despite a dip in inflation.
At a bond auction this week, yields on 2- and 5-year bonds fell to 15.16 per cent and 15.39 per cent, from 15.64 per cent and 17.96 per cent at the previous sale.
The Ugandan shilling slid after the auction, suggesting that foreign investors had stayed away.
"Immediately after the auction we saw the local currency depreciate to 2,500/2,516," said Ahmed Kalule, financial markets dealer at Bank of Africa Uganda.
"That was an indication that maybe we didn't have so much offshore participation."
However, Kalule said foreigners might be tempted to buy Treasury bills at next week's auction as rates on the instruments have been closer to inflation.
"I think there will be some offshore participation because 20 per cent for 1-year paper is not so bad when inflation is around 20.3 per cent," he said.
Higher inflation and a weakening naira are likely to steepen Nigeria's yield curve after rates increased at a Treasury bill auction this week.
The central bank sold a total of 126 billion naira ($791 million) in treasury bills ranging from three months to one year at the auction, with yields higher than at the previous sale.
The 91-day bill was sold at a yield of 13.50 per cent, up from 13.19 per cent.
The 182-day instrument was issued at 14.14 per cent, compared with 13.87 per cent previously, while 1-year paper yielded 13.30 per cent, from 13.94 per cent.
Traders said most of the activity was focused on the short-end, with inflation concerns driving up Treasury bill yields.
"Higher inflation and declining value of the naira will continue to drive up the yield curve on the lower end of the market," one dealer said.
The naira was trading at 160.12 against the dollar on Friday. The currency has stabilised around 157 to the dollar for more than three months this year.
Samir Gadio, emerging markets strategist at Standard Bank in London, said the depreciation was initially triggered by foreigners selling T-bills.
"Although the offshore selling appears to have relatively subsided this week on the fixed income side, some foreign investors have continued to exit their NGN-denominated positions," he said in a note.
($1 = 85.4 Kenyan shillings) ($1 = 2496.5 Ugandan shillings) ($1 = 159.6 naira)