The Week that was (August 13-17): – Foreign sales drive bond yields higher amid a dovish CBN posture
- Foreign dumps drive FGN bond yields higher: Continuing from last week, foreign bears continued to drive bond yields higher. Whether on account of the negative press from the siege of the National Assembly or the emerging turmoil in Turkey, foreign portfolio investors are finding an excuse to ditch NGN assets. In addition, it would appear that a pick-up in local shorts looking to get favourable prices at the monthly auction also worked to push yields higher. At the monthly bond auction, the DMO sold NGN110billion worth of bonds (69% of its planned offer) at higher marginal rates of 14.56% (July 13.99%). Though bid cover ratio for the auction came in higher at 1.1x (July 0.9x), adjusted for non-competitive bond sales of NGN70billion, subscription demand at the auction was low. Post the auction, bond yields briefly declined but the bearish trends resumed on Friday and pushed longer dated tenors over 15%. Fundamentally, it is important to note that FGN bond yields are nearly 100bps above December 2017 levels, even though oil prices are stronger and inflation is 420bps lower.
- But CBN remains dovish in money markets: At the short end, markets remained sufficiently liquid as the CBN only took out NGN155billion via its weekly OMO auctions relative to maturities of NGN440billion which held down OBB and overnight rates at 7.33%and 8.33% respectively. The reluctant CBN posture at curbing NGN liquidity is interesting in the light of the furor caused by supposedly hawkish commentary from the its Deputy Governor in the prior week. That said, the bond market sell-off worked to catalyze bearish trends along the front end as institutional investors worked to rotate into higher yielding positions by selling off money market placements. In Nigeria’s rate cycle, yield levels of 250bps around long run inflation of 12% trigger bullish activity. Under a normalizing yield curve as we are currently looking at, the natural inclination is to sell down on NTB positions which underpinned a rise in benchmark Nigerian Treasury Bills (NTB) up 18bps on average: 91-day (discount: 11.28%, effective: 11.6%), 182-day (discount: 12.43%, effective: 13.25%) , 364-day(discount: 11.96%, effective: 13.44%).
- Inflation continues to slide but downtrend now appears to have bottomed out: In line with expectations on Broad Street, headline inflation slowed to 11.14% in July (June: 11.23% y/y) marking the 18th straight month of declines. Interestingly, monthly CPI also reclined to 1.1% (June: 1.24%). Looking closely at the CPI report, aside base effects, food inflation showed some moderation with the monthly reading down to 1.4% (June: 1.6%) which largely stemmed from processed foods and non-alcoholic beverages as farm produce prices remained flat from June levels. The sense I get is that the usual ‘lean season effect’ which tends to drive monthly food inflation higher between May and July has peaked in June for 2018. Though its probably too early to call but my suspicions are that food inflation look set to descend in coming months dragged lower by farm produce as harvest supplies assume a stronger impact in driving down food prices. Given muted core inflation due to stable fuel and electricity prices, my forecast is that inflation is likely to hover 11.2-6% y/y over the rest of 2018 with 2018 average settling around 12.2%. (2017: 16.5%).
Figure 1: 2018 Headline Inflation: Actual and Forecast
Source: NBS, Authors Computation
- CBN profits declines for the first time in 2017: Regular readers of this blog will recall that coming into 2018, I had noted that CBN annual reports for 2017 would be an interesting read. Why? In pursuit of its ultra-tight monetary policy stance, the CBN pushed OMO issuance to record levels and at elevated effective interest rates of between 18-22% for the first nine months of the year. The cost of these borrowings was that it incurred interest expense of NGN1.3trillion resulting in a net interest expense of NGN659billion vs net interest income of NGN295billion. Observe that Nigerian banks had solid earnings growth in 2017 thanks to high interest income on government securities. To save the day, the CBN relied on a jump in other operating income to NGN1.5trillion (2016: NGN898billion), lower fair value losses on financial instruments and no financial sector intervention expenses after it took over Skye Bank in 2016. Though the detailed breakdowns were not provided, looking at the balance sheet reveals a lumpy jump in external from NGN8.4trillion to NGN14.6trillion. Given that the official exchange rate was flat at NGN305/$ for 2017, the 74% jump on CBN’s balance sheet which compares with only 44% y/y rise in external reserves to USD38.8billion implies that the apex bank used another exchange rate definition in its accounting treatment.
The Week Ahead (August 20-24): Yield curve normalization ahead?
- In the short three-day trading week ahead due to the Eid holidays, system maturities drop to NGN364billion entirely of OMO bills while FAAC inflows are expected.
- If anything, the key insight from the CBN 2017 annual report is that the apex bank needs to find a way to remain profitable in 2018 which means keeping the cost of its OMO issuances low and/or shrinking the size of OMO position estimated at NGN10trillion. This means the CBN is likely to keep a dovish posture in money markets to lower the cost of OMO auctions and recover some policy legroom for the next crisis. Indeed, markets are likely to see more liquidity at the front end after the CBN finalized plans with banks to deploy CRR liquidity following last week’s Bankers Committee meeting. So why all the hawkish talk? I think this is simply to support the exchange rate in its quest to cultivate foreign investors attention in NGN assets.
- For the long end, markets have observed that the FGN now needs to fund its 2018 budget, following passage in late June, which means that unlike in H1 2018 when the DMO didn’t need to fill-up its borrowing till, it is now under modest pressure to meet borrowing targets. This paints a bearish outlook for bond markets as we will see a slightly more desperate DMO, a continued overhang of foreign sellers looking to exit Nigeria, constant hawkish CBN commentary (though actually dovish) and negative noise from the political environment. This cocktail suggests no an end to the present bond market turmoil until either the event that the FGN clears its Eurobond sales or oil posts a miraculous recovery back to USD80/bbl. I would also include the possibility of JP Morgan EMBI index inclusion as a trigger for bond market bulls.
- In summary, the outlook is for higher bond yields and lower short-term rates which implies that a normalizing yield curve is the most likely shape we would see over the rest of 2018. Though as regular watchers of Nigerian debt markets would know, this rare phenomenon means something is just around the corner and my suspicions are that post-election we see the long end dip significantly rather than the front-end rise.
Figure 2: Naira Yield Curve
- OMO: Open Market Operations
- CP : Commercial Paper
- NTB: Nigerian Treasury Bill
- FGN: Federal Government of Nigeria
- CBN: Central Bank of Nigeria
- DMO: Debt Management Office
- PBoC- Peoples Bank of China
- FAAC: Federal Accounts Allocation Committee
- I&E: Investors and Exporters Window
- MPC: Monetary Policy Committee
- NBS: National Bureau of Statistics