Nigeria Fixed Income Weekly

The week that was (April 23-27)

CBN signals interest rate floor: Consistent with the pattern in recent weeks, debt markets continued to grapple with the gravitational pull of robust NGN liquidity levels which continued to leave Overnight/OBB rates at depressed levels of ~3%. However, markets reacted to a surprise increment of OMO discount rates by 5bps and 10bps to 10.95% (effective: 11.3%) and 12.05% (effective: 13.1%) for the 3M and 9M bills respectively. This comes after progressive moderations in recent weeks and suggests CBN is now setting a floor on how low it is willing to tolerate interest rate declines to sustain offshore interest in NGN debt. Alongside, slightly aggressive OMO sales of NGN277billion, in the face of only NGN226billion maturities, the higher marginal clearing rates underpinned a rise in short dated interest rates with the 3M and 6M bills up 55bps and 5bps respectively to 11.01% and 11.51% respectively. However, the robust system liquidity levels diluted impact of this ‘tightening’ on the 1yr NTB as yields declined 154bps to 13.25%.

FGN bond yields slide below 13% at the primary auction: In lockstep with the bullish pattern in recent weeks in secondary trading of FGN bonds, heavy subscription at the monthly auction allowed the DMO borrow NGN140billion at an average of 12.83% (March: 13.5%) – the lowest level in two years. Bid cover ratio climbed to 2.2x (March: 2x) with robust demand for the 10-year instrument where subscriptions were 5x the offer. This is testament to sizable liquidity at the deep end of the FGN yield curve and underpinned bullish sentiments. Though profit taking at the end of the week trimmed weekly gains, he overall sense is the bullish pattern still has legs ahead of May’s bond maturities.

Figure 1: Marginal clearing rates, bid-cover and allotment ratio at monthly bond auctions

Issuance.png

Source: DMO

CBN’s monetary growth targets: As part of its routine policy procedure, the CBN released its 2018 targets for money supply growth which would see the apex bank target 10.9% growth. After a muted 1.2% rise in 2017, where an ultra-tight monetary policy posture to suppress USD demand undermined the 10.3% target, my impression is these targets are a mere formality which mean nothing in the scheme of things. Nigeria’s monetary policy has nominal exchange rate stability as its primary objective. The trajectory of money supply aggregates (and indeed interest rates) is a derivative, firstly, of policy instruments directed towards achieving that primary goal, and CBN comfort over the near-term outlook for the NGN. For evidence, despite having a target for double digit expansion in 2017, the CBN attacked NGN liquidity by deploying largely unconventional tactics to curtail growth in net domestic assets.

Figure 2: NGN Yield Curve

NGN yieldd curve

Source: FMDQ

The week ahead (April 30-May 4)

In the week ahead, system maturities rise to NGN377billion evenly split between NTB and OMO paper which means auctions on Wednesday and Thursday respectively. The mid-week NTB sale will see the CBN issuing 50% of what matures, meaning a fairly robust liquidity level over the course of the week which will continue to apply downward pressure on the NGN yield curve. However, markets are likely to take CBN guidance from the OMO sale last week as the floor for rates pending fresh downside to inflation or likely re-inclusion of Nigeria to the JP Morgan GBI-EM. This latter point is non-trivial as with the one-year anniversary of the Investors and Exporters window, the index providers have had one year of observations to make a decision.

With oil markets now getting set to make a run for USD80/bbl price which bolsters a sanguine thesis over NGN stability, improved prospects for single digit inflation over H2 2018 lays a fundamental case for an extended rally in NGN fixed income. Given the robust liquidity levels in the I&E market with no hindrances for foreign investors seeking to enter and exit NGN assets, the case for including Nigeria on the JP Morgan GBI-EM looks favourable.

As I noted last week, current bear expectations of a foreign sell-off in NGN assets ahead of the 2019 elections may be need to be updated. In my view, what is likely to occur is a rotation from NGN equities to NGN fixed income, given FX rate stability, as a coping mechanism for uncontrolled volatility of equity markets. The foreign investor class in Nigeria is dominated by battle hardened sharks who are used to dealing with political risk across frontier markets.

 

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