The week that was (October 23-27) – Tight liquidity conditions drives yields modestly higher
- CBN’s renewed onslaught on liquidity amid thin maturities nudges rates higher: In a continuing pattern from the prior week, the CBN maintained its assault on NGN liquidity with issuance of N181billion worth of OMO bills as against N93billion in maturities which meant that the overall system liquidity was wafer thin. Already, coming into the week, system liquidity was already pressured (with OBB/Overnight rates at elevated levels of over 100% at the close on Friday) as banks prefunded for the FX intervention sale. Added to the fact that the week also featured a liquidity draining event with a bond auction, thus, rates closed higher with benchmark Nigerian Treasury Bill (NTB) yields climbing 30bps to 91-day (discount 18.51%, effective: 19.39%), 182-day (discount 17.62%, effective: 19.24%) and 364-day (discount 15.49%, effective: 18.25%).
- Bonds rise and fall: In line with the sell-offs at the short end, bond yields rose over the week in secondary trading as traders took advantage of the tight liquidity conditions as an excuse to book some profits. However, at the monthly bond auction where the FGN lowered the amount on offer to N100billion, average marginal clearing rates slid for the second consecutive month (down 94bps to 15%) despite tamer bid-offer ratios (1.7x vs 3x in September). Markets continue to remain be fearful of lower government borrowings and likely dovish monetary policy in 2018. In addition institutional offshore buying demand continues to come in when prices drop significantly.
- In summary, amid low system liquidity levels, sustained CBN OMO aggression underpinned a mild rise in yields across the curve.
Chart 1: NGN yield curve
Source: FMDQ, NBS
The week ahead (October 30-November 3) – Benign inflation outlook on the cards?
- In the week ahead, system maturities rise to N195billion split between NTBs (48%) and OMO bills (52%) with the implication of the former being that a primary market auction takes place on Wednesday. Alongside FAAC inflows, we have the first STAB maturities coming up this week, so overall system liquidity appears fairly robust.
- Legislative delays on the Eurobond sale: It’s been over a month since the DMO pushed the idea of issuing $5.5billion in Eurobonds though after initial traction in the media, the idea has slipped out of sight. The delay is in contrast with the March issuances, where parliamentary approval was in days even though the 2017 budget was not yet passed. The difference reflects the fact that to clear the hurdle, the DMO claimed that this borrowing was to finance the deficit on the 2016 budget where it had approval to borrow Eurobonds and as such legislative approval was a mere rubber stamp. But this new issue is tricky as while the DMO has approval for $2.5billion as per the 2017 budget, the extra $3billion is a newcomer and as such will require fresh examination. Thus the senate has pushed it to committee sitting and this explains the recent media blitz by the DMO/Finance ministry in a ploy to obtain speedy approval.
- CBN’s single digit prediction by halftime 2018: Last week, the CBN governor, at the sidelines of an investor conference painted a benign inflation outlook over 2018. In particular he forecasted that inflation would hit single digits by mid-year. My initial reaction, given the sluggish CPI retreat in 2017, was that it was not feasible. But in retrospect, and having examined these numbers, single digit inflation by June 2018 does not appear to be wishful thinking. Following significant supply side shocks (67% increment in fuel prices and 45% hike in electricity tariffs) under an atmosphere of sizable exchange rate devaluation, monthly inflation has averaged 1.3% in the last two years. That said, since August, monthly inflation has dropped sub 1%.
- If one takes an optimistic view regarding the current strength in oil prices and assumes no major upshot in militant attacks, then we are unlikely to see any major exchange rate shocks on the cards in 2018. Over the last decade the slowest pace of monthly inflation is 0.64% m/m (2007, 2013, 2014). With the government plan to delay electricity tariff adjustment to July 2019, which also implies resistance to any planned fuel price hikes then monthly inflation looks set to drop under 1% in 2018. Playing around with the monthly average spits out single digit readings in the second half of 2018 for 0.6-0.8% m/m readings.
- Whatever pattern plays out, inflation is likely to fall below the 12% threshold for inflation that the CBN mentioned at the July MPC. Thus, it would appear that CBN’s withdrawal of the 1-year OMO bill and lukewarm attitude to liquidity is consistent with a view that the apex bank expects inflation to dip to single digits by half-time. Given the bulging maturity profile over 2018 with over N2trillion, these influences point to dovish bias to interest rates over Q2-Q3 next year.
- The sizable liquidity events points to rates coming under pressure. November is a month of higher maturities so bond market bulls look set to re-appear this week so tread cautiously at the auction.
Chart 2: Inflation: 2018 sensitivity analysis
Source: Authors computation