During the last 14 months the Romanian yield curve shifted downwards. The move has been accelerated since November 2011 as the central bank started to lower its key policy rate while injecting liquidity at the short end (7-day repo auctions). This has allowed the Romanian government to borrow cheaper but short maturities and has led to the yield curve depicted below.
What does this curve (i.e. Romanian financial market) tells about the future of the Romanian economy?
The latest sharp drop in the short end of the curve suggests that the financial markets expect one more cut from the NBR. But the fact that the curve slopes upwards tells us that players in this market (mostly local banks) expect monetary policy to increase rates afterwards (short term rates to increase).
Given the current inflation forecasts from the NBR there should not be a reason for the market to expect higher short term rates in 12 months. The only reason would be if the market players expect inflation to increase in spite of the central bank’s forecasts.
In the same time if we look at the spread we see a different picture. As there is no applied work on the fixed income in Romania I use 4 different measures of the spread: 10yrs-6mth, 5yrs-6mths, 3yrs-6mths, 1yrs -6mths. Also, it is important to note that most liquidity is found in maturities up to one year. Nevertheless, it is quite clear that the spread has been falling recently for all these measures. If what works in other economies applies to Romania then the spread signals a weak Romanian economy ahead (but not recession yet).
Thus, we have two signals from the Romanian financial markets: increasing short term interest rates in the next 12 months due to higher expected inflation and a slowdown in the economic growth (not recession yet).