The week that was (August 28-31) – Surprise ‘lull’ in CBN liquidity tightening weighs on short-dated yields
- CBN stands pat on system liquidity: After maintaining a tight stance on system liquidity, CBN for the first time in a while, eased off and allowed a net repayment of N82billion in OMO bills. The development follows several failed auctions which included a departure in tenor on offer from the 183/344 day OMO bills to the introduction of lower duration bills: 45-day, 98-day and 175-8day. Curiously CBN appeared to reject market pricing on lower tenors even as the risk of allowing NGN liquidity build up given the redemption of nearly N100billion in bonds. Largely reflecting the build-up in system liquidity benchmark Nigerian Treasury Bill (NTB) yields declined 90bps on average to 18.97% (91-day) 19.57(182-day) and 22.06% (364-day). The improved system liquidity was evident in the drop in overnight/OBB rights to single digits (7.3%/8.4%) from 25/26% at the start of the week.
- At the NTB primary auction, discount rates continued to fall as the 91-day closed at 13.3% (effective: 13.76%), 182-day at 17.361% (effective: 19.01%) and 1-yr at 18.52% (effective 22.72%) with the FGN successfully rolling over N193billion in maturities. As usual, the FGN filled the under-subscribed 182-day tenor with over-subscription on the 1yr tenor.
- ..allowing a pause in the sell-offs in bonds : The halt in CBN tightening also permitted the influence of N100billion in FGN 2017 maturities on the long end of the curve with declines on the two year tenors. Other tenors declined from highs at the start of the week to between 16.41-16.81%.
- Inflation declines for the sixth consecutive month: The National Bureau of Statistics (NBS) announced that inflation declined to 16.05% y/y with the m/m reading at 1.21%. That said, much of the focus in the press has been on food inflation which hit an eight year high of 20.3% y/y meaning that a drop in core CPI inflation to 12.2% y/y underpinned the decline in the headline number. However a focus on the headline number, given the large base effects from 2016, is misleading as the underlying inflation pattern from looking at the m/m readings where headline and food pulled back from the elevated readings in H1 2017 suggests things an inflection point. Specifically, the monthly headline reading slowed to 1.2% from 1.6% in June on account of a second consecutive deceleration in m/m food inflation to 1.5%.
In summary, a confluence of higher system liquidity after CBN surprisingly elected to allow maturities go untouched amid a lower CPI reading drove a softening across the yield curve
The week ahead (September 5-8) – Exit from recession and soft whispers of liquidity easing?
- In the week ahead, there is a N135billion OMO bill maturity on Thursday and the CBN should release the Q4 2017 NTB issuance calendar. Towards the end of the year NTB calendars are usually in net-repayment mode and I expect this calendar, in the light of comments by the Finance Minister about NTB refinancing, to show hints of tamer fiscal issuance at the short end of the yield curve.
- Nigeria officially exits recession: In addition, the NBS released Q2 2017 GDP estimates today with Nigeria exiting recession with a tame 0.55% y/y expansion in output. Central to the rebound was a recovery in oil GDP growth by 1.6% y/y (vs 11.6% y/y contraction in Q2 16 and Q1 17). However non-oil growth was soft owing to an unexpected contraction in telecommunications GDP following a plunge in subscriber numbers due to a regulatory induced line de-activation. Furthermore, an extended contraction in Trade GDP meant that growth in non-oil was quite disappointing. The import of the weak Q2 17 number is that it lowers real GDP forecasts to sub 1% y/y in 2017.
- But what does the failed OMO sales mean? The failed auction has two implications. First, pension funds whose holdings on Treasury bills have climbed are sore towards lower duration bills hence the week participation of the OMO auctions. The second point involves trying to inteprete CBN’s rejection of auction pricing. On the 45-day, the upper range of bids was at 17.83% – 100bps higher than market pricing on the day, so CBN’s rejection was in order. On the other hand, the rejection of market pricing for the 98-day sale with upper bid rates slightly lower than secondary market yields suggests discomfort with rates. Importantly, the only successful auctions last week were on the longer near 6M tenors, where bid rates were roughly in line with secondary market pricing. While the introduction of newer lower tenors suggests an attempt to manage maturity profile in 2018, the lack of a desperation to sap NGN liquidity marks a change in CBN approach and possibly suggests comfort. That said one week is a small sample to stretch any theory of liquidity easing. However should the trend of failed OMO sales continue ahead of the MPC, then we cannot rule out an outside chance of a pre-emptive 50-100bps rate cut in September to lower the real return between the short end of the curve and inflation. Either that or the CBN resorts to fresh STAB issues as in the recent past. Thought it is unlikely to continue to get away without some push back or noise from the banks should it lower the rates on these securities. In any case we are more likely to see net repayments into the system which should favour bond market bulls over the week.
Over the rest of the four-day trading week, watch out for trends at OMO auctions,: as markets are likely to interprete further failed auctions as a dovish inclinations by the CBN which would underpin fresh bullish sentiment. I expect this to weigh switch in tenor offering to drive fresh buying on the 6M-1yr tenors while a more liquid system drives contraction in bonds.
Chart 1: NGN yield curve and Inflation
Source: FMDQ, NBS