The Week that was (July 2-6): – Offshore bears continue to drive yields higher, CBN remains passive
- Offshore selling fuels bearish sentiment in bonds market: Continuing from last week, foreign sellers continued their retreat from Nigeria’s debt markets ahead of the 2019 elections and spurred by the recent turmoil across emerging and frontier markets. That said, it is important to note that underlying transactions are not as large as implied from the sell-offs as local investors remained on the sidelines, still waiting to gauge the intensity of the foreign bears. This relative shortage of buyers is what appears to be driving the divergence between interbank bond quotes and actual trades as captured by FMDQ. For the record FGN bond yields closed the week 22bps higher on average at between 13.5% to 14.33% but most interbank quotes are generally higher between 13.9-14.6%.
- But CBN aloof on NGN liquidity continues to force front-end rates lower: Despite the sell-offs at the long end, short dated yields continued to struggle against the robust liquidity tide as the CBN again elected not to sterilize Thursday’s NGN239billion OMO maturities which alongside the spillover from the prior week worked to depress overnight and OBB rates to 12.92% and 11.33 % respectively from 32.5% and 30% at the start of the week. Accordingly, the bulls took over the front end pushing yields on Nigerian Treasury Bills down 69bps on average: 91-day (Discount: 11.61.%, Effective: 11.93%), 182-day (Discount: 12.18%, Effective: 12.97%) and 1-yr (Discount: 12.18%, Effective: 13.40%).
- As I’ve noted despite putting up a hawkish posture in its MPC commentary, the CBN actual posture in money markets has been largely dovish which has had the most impact on yields on short dated instruments which plummeted over Q2 2018. Why are they lukewarm? My guess is that the apex bank remains comfortable with its FX reserve outlook and a declining inflation picture. Absent the onset of the 2019 elections, there is limited reason for higher bond yields from current levels as thanks to stronger oil receipts government borrowings have been largely subdued in 2018 amid ample demand from the rising maturities.
Figure 1: Naira Yield Curve
Source: NBS, FMDQ
- CBN quietly drives FX market convergence: Despite the turmoil across global FX markets, the NGN has remained a beacon of stability. Ok the exchange rate weakened to NGN361/$ big deal. But the parallel market rate has appreciated to NGN361/$ having softened to NGN365/$ at some point and the official remains moored at NGN305/$. All is well right? Not quite, the little known NIFEX rate has been on the move rising to NGN347/$ from NGN331/$ at the start of the year. NIFEX is the rate at which CBN interventions occur and its depreciation reflects an attempt to prevent rate shopping between its interventions and the interbank/I&E window rate. Adjusted for the interest rate banks charge on FX loans to finance imports, both rates have effectively converged. That leaves the official rate where transactions volumes are largely for oil imports. I expect no convergence on this front till after the 2019 elections as long as the current account remains in surplus.
- We have closure on the largest ever Commercial Paper sale: Dangote Cement announced closure of its NGN50billion commercial paper with a discount rate of 12.4% (effective yield 13.2% for the 180 days, while that of the 270 days has a discount rate of 12.65% (effective yield of 13.96%). Though its still early days, the development of the CP market is big plus for the long-term development of Nigeria’s debt market as it allows good quality corporates price loans appropriately. This is as now these blue-chip companies have an alternative to bank balance sheets for both working capital and capital projects in local currency. Increasingly, this frees up liquidity for banks to go after more risk assets unable to access debt markets. Word is that MTN is also in the pipeline to tap debt markets. Watch this space.
The Week Ahead (July 9-13): Offshore bears, DMO Q3 borrowing calendar and June Inflation
In the week ahead, system maturities fall to NGN313billion entirely of OMO bills. However, we are likely to see FAAC inflows as well. In terms of what to expect headline inflation readings for June are set to be released on Friday and the southward grind looks set to continue though at a much more subdued pace with my forecast at between 10.9%-11.1% y/y (May 11.6% y/y) reflecting continued base effects and the stability across the exchange rate. Elsewhere, the week also sees the release of the Q3 2018 bond calendar. With the passage of the budget, we expect to see a pick-up in domestic borrowings but plans to tap global debt markets for Eurobond imply that the DMO might continue to keep its cards tight. That said, borrowing levels are set to remain soft relative to 2017 issuances thanks to the stronger revenue profile.
Yield curve steepening or flattening? There has been some talk about prospects for a steepening yield curve given the divergent moves along both segments: excess liquidity applying downward pressure on the short end and the offshore bears pushing yields higher. A steepening would materialize if bond yields push towards (and above) 15% without any accompanying movement from the short end. This view looks conventional as investors should be rewarded for duration. However, the NGN yield curve has historically stayed largely flat to inverted with the inversion more frequent and typically driven by hawkish CBN monetary policy. Bond yield spikes tend to be more persistent when driven by a cost insensitive FGN during periods of revenue shortfalls from oil price slumps. Neither is happening now nor likely to happen over the rest of 2018 given a largely supportive oil price picture. The current rise is driven by foreign fund managers seeking to minimize exposure to Nigeria ahead of the 2019 elections. Once this thin livered lot have completed their retreat, I expect the yield curve to flatten out. In the interim, domestic fixed income markets will continue to grapple with the offshore sellers at the long end and a lukewarm CBN keeping yields restrained at the short end.
- OMO: Open Market Operations
- NTB: Nigerian Treasury Bill
- FGN: Federal Government of Nigeria
- CBN: Central Bank of Nigeria
- DMO: Debt Management Office
- FAAC: Federal Accounts Allocation Committee
- I&E: Investors and Exporters Window
- NBS: National Bureau of Statistics