The week that was (Sept 18-22) – Lukewarm CBN stance on liquidity triggers strong buying across the curve
- Bulging liquidity drives downward shift in the yield curve: In line with the declining pattern since the end of August, the Naira yield curve continued to drop as a passive CBN approach to system liquidity continued to create an environment for debt market bulls to drive rates south. Over the week, benchmark Nigerian Treasury Bill (NTB) yields declined on average 74bps in secondary trading to close at 18.33% (discount 17.54%) for the 3M, 17.7% (discount 16.28%) for the 6M and 19.77% (discount 16.5%) for the 1yr paper. Though the CBN’s gross OMO bill issuance of N291billion exceeded OMO bill maturities of N141billion, the build-up in liquidity in recent weeks and termination of 1yr OMO issuances overrode impact of the strong net paper issuance at the close of the week.
- Liquidity deluge drives a collapse in rates at NTB auction: In line with secondary market trends, primary auction yields also succumbed to the liquidity pressures with stop rates of 13.15 (3M), 16.8 (6M) and 17 (1yr). At the auction, where the FGN wanted to rollover N141billion, the decline in rates allowed them to borrow an extra N75billion due to robust subscription levels of nearly 4x. While the declining pattern at the 3M and 6M had been expected, the 75bp slump in 1yr reflected massive subscription at the tenor with bid-cover of 5.6x allowing the CBN upsize the intended N89billion offer by 89%.
- The dramatic collapse is a fall-out CBN’s termination of the 1yr OMO bill which resulted in limited paper supply of the tenor which had become a favourite hunting ground for domestic pension funds seeking to pick-up yield at the short end of the yield curve. The robust subscription levels is evidence of the liquidity build-up in recent weeks and is also indicative of strong pension fund involvement.
- Bonds feel the weight of buying activity: The deep end of the Naira yield curve was not insulated from the debt market bulls, as pension funds who could not justify going deep down short duration amid fears that a rate cut was on the cards, began buying longer duration instruments which fuelled a 30bps contraction in yields. This occurred despite the FGN sale of N100billion 7-year Sukuk bond issuance.
- In summary, bulging system liquidity a fallout of CBN’s lukewarm posture to Naira liquidity fuelled a bullish run in debt markets.
The week ahead (September 25-29) – A static MPC and a bond auction
- In the new week, the CBN commences its two day monetary policy retreat today, there is a bond auction on Wednesday where the FGN would offer N135billion and an OMO maturity of N123billion on Thursday. As in prior weeks, markets movements will be dictated by CBN’s posture with regards to system liquidity.
- What to expect from the MPC meeting? From my experience looking at domestic debt markets and monetary policy in the last five years, a very strong predictor of MPR movements is CBN’s positioning in terms of whether it is a net issuer or net repayer at its weekly OMO auctions. The pattern since the end of August and the collapse in rates naturally spurred rumours that a rate cut was on the cards at this MPC. That said, CBN’s stirring comeback on Thursday with aggressive net issuance on the 6M paper, at above secondary market rates, implies that an intent to curb Naira liquidity remains strong.
- So why has the CBN stood idly by in recent weeks? My guess is that it reflects one of three things. First, a possible desire to slow down on rising OMO maturities at the 1yr tenor by shifting to lower tenors. As the market was not biting this attempt at the end of August, the CBN decided to play its hand by allowing liquidity build-up to force rates lower such that markets now look favourably at the lower tenors. Secondly, it could reflect a desire to adjust the yield curve to capture the downtrend in inflation which the market continued to ignore. A third point, though one with no direct proof is that monetary authorities are playing a game of tag with the fiscal side to ensure lower borrowing costs for the FGN after the failed bond auction in August.
- With success on the first two points, I expect the CBN to remain static as to ease would not be credible given its usual excuse of above target inflation. Importantly, as I noted, their desire to sap liquidity remains firm as evidenced at the close of last week. In any case as regular watchers already know, the MPR remains purely symbolic (as I often say for Bloomberg, Reuters and journalists to write fancy stuff about) and the real rate theatrics take place in the money market at OMO window where rates have come down but remain above inflation. Thus, on balance, I expect the CBN to hold rates though watch out for forward guidance about conditions for monetary easing.
- How to play the FGN bond auction? At this week’s auction, the FGN would intend to borrow N135billion split across the 2021 (N35billion), 2027 (N50billion) and 2037 (N50billion). Two things will be crucial at the auction the sense of bond market liquidity post the Sukuk bond and where market is at the close of Tuesday given the fluid nature of events. The coupon for the 2021 is 14.5% well below current market yield of 16.02%, which means subscription for the tenor is likely to be soft. For the other two tenors, current market rates have dropped to sub 16%, below coupon rates on the issues meaning that you’re likely to find robust demand here. Under a bulging liquidity environment and if we see a repeat of CBN’s passive stance, bidding in line with market rates is a safe strategy as one clearing rates fits all for bond auctions.
In all, I expect the MPC to hold the status quo on Tuesday. In terms of how the market responds, we are likely to see cautious trading ahead of the bond auction on Wednesday. Should the CBN hold fire in terms of liquidity mopping via OMO, then expect further downward pressure on rates across the yield curve.
Chart 1: Yield Curve
Source: FMDQ, NBS
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