The week that was (October 15-20) – Divergent trends across the curve
- CBN’s liquidity curbing antics drives short dated rates higher: In a continuation from last week, the CBN continued to slowly clamp down on system liquidity with issuance of N184billion worth of OMO bills as against N166billion in maturities which nudged benchmark Nigerian Treasury Bill (NTB) yields 40bps higher over the week in secondary trading.
- However, at the primary auction, discount rates continued to slide (down 14bps from the last sale): 91-day (13.1, effective: 13.4%) 182-day (15.3, effective: 16.56%) 1-yr (15.59, effective: 18.46%). In another development, bid to cover ratio slid to 1.5x from 4x at the last PMA which possibly suggests that demand has moderated given the lower real returns on offer at the primary market relative to secondary trading levels.
- OBB and Overnight rates surged at the close of the week to 110/118% from 33/35% at the end of the prior week as banks pre-funded for retail SMIS sales at the close of the week.
- Bonds remain subdued as pension funds remain isolated to their ‘habitat’: In contrast to the short end, bond yields remained firmly into negative real return territory as the fear of reinvestment risk continued to support increased buying activity at the segment by pension funds in a classic case of habitat theory. In addition, concerns over shrinking fiscal issuance in Q4 2017 continued to keep yields range bound. That said, the sizable expansion in negative real return amid a downward sticky inflation trajectory suggests markets are approaching the limit.
- Inflation continues its slow grind south? The National Bureau of Statistics (NBS) released inflation numbers last week which showed that headline inflation slid 3bps to 15.98% y/y while m/m slid to 0.77% (August: 0.9%). The deceleration in m/m stemmed from food inflation, which rose at its slowest pace in eleven months (0.87%) as harvest supplies applied downward pressure on food prices.
- In summary, the return of CBN aggression in curbing pushed NTB yields higher. However, pension funds, now isolated from chasing real return, amid growing concerns over reinvestment risk, continue to keep longer dated subdued.
The week ahead (October 23-27) – Much ado about a bond auction and the 2018-2020 MTEF
- In the week ahead, system maturities dip to N93billion worth of OMO bills on Thursday and in terms of events the monthly FGN bond auction is on Wednesday with N100billion on offer. In addition, the FGN would continue its quest to obtain National Assembly approval for its proposed $5.5billion issue.
- Snippets from the 2018-2020 MTEF: In terms of medium term outlook, the budget office unveiled its 3-year expenditure outlook which suggests the FGN would seek to spend raise its budget to N8.6trillion in 2018 (+12% y/y). Importantly planned debt service slots in at over N2trillion as against N1.6trillion budgeted for 2017. Though the plan does not explicitly state how deficits will be financed it hints at a likely ramp up in foreign borrowings over the outlook. Whether this will include a focus on debt refinancing is unclear, that said, the elevated debt service number and rising trajectory suggests NGN borrowings will remain high.
- Another issue of interest is the MTEF assumption of a 30% increase in electricity tariff in July 2019. This implies static trends in electricity tariff till after the elections and removes a key risk to inflation in the medium term. Clearly the government appears more concerned about further damage to its political capital ahead of the elections which likewise dampens prospect of fresh hikes in fuel tariffs in the near to medium term.
- How to play the FGN auction? At the bond auction, the DMO would seek to auction N100billion which will be evenly split between the 5-year and 10-year tenors which currently trade at 14.88% and 14.81% respectively in the secondary market. Both issues are re-openings with coupons of 14.5% (5-yr) and 16.28% (10-yr). My guess is the higher coupon relative to market would drive higher pension fund preference for the 10-year and suggests cautious bidding on the tenor with 14.5-14.8%. For the 5-year, a safe strategy might be to bid at the coupon. Unlike NTB sales where you get what you hit at, bond auction sales allow a wider margin of safety if you bid low. In an environment where the FGN appears less desperate, caution is the word.
- Ahead of the FGN bond sale, I expect the CBN as in recent weeks to display a reluctant attitude to liquidity ahead of the auction to ensure softer borrowing costs for the FGN but pick up the pace after Wednesday which might mean higher short dated rates.
Figure 1: NGN yield curve
Source: FMDQ, NBS
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