Nigeria Fixed Income Weekly

The Week that was (November 19-23): – Yields decline as CBN dials down on tightening rhetoric

  • CBN holds, but largely subdued tone at the MPC: At the last monetary policy meeting in 2018, the CBN opted to hold all policy parameters by a unanimous decision contrary to my expectations for a small hike. Even more, while I expected more hawkish rhetoric in the light of the swift descent in FX reserves and lately in oil, the CBN sounded rather calm pointing to weak credit growth and concerns over the economy. Following from the MPC, the CBN switched from net liquidity withdrawals observed in the last two weeks to a net liquidity injection as OMO issuances of NGN199billion trailed OMO bill maturities of NGN409billion. The improved system liquidity resulted in declines in secondary market NTB yields (down 20bps w/w on average) to 13.38(3M), 13.62% (6M) and 16.88% (1-yr).

Figure 1: Naira Yield Curve

NGN curve

Source: NBS, FMDQ

  • DMO adopts market neutral posture at monthly bond auction: At the monthly bond auction, the DMO turned tight fisted in the face of low demand with bid-cover of 0.9x (October: 1.25x) and opted to only fill-up 34% of its planned NGN105billion offer. This miserly view implied that they were only willing to fill up bids at rates in line with the secondary market levels i.e. they adopted a market neutral rates. This is consistent with the view that with the Eurobond sale, government near term borrowing needs are covered and as such less need for going aggressive at bond auctions. The development had a negative impact on yields as short covering following the auction drove a retracement in FGN bond yields and they closed the week down 7bps on average.
  • October 2018 Inflation – Harvest is here: After an unusual delay, the NBS released October 2018 CPI report card which showed a deceleration in headline inflation to 11.26% y/y (September 11.28% y/y). Consistent with the slowing pattern since June, monthly inflation slipped to 0.74% (September: 0.84%) largely due to a moderation in food inflation (in particular farm produce) as core inflation inched up over the month (October: 0.84% vs 0.64%). With the main harvest of grains and tubers underway in most parts of Nigeria, seasonal declines in food prices tend to drive a moderation on overall inflation and this is likely to be the picture over the next two months. YTD inflation has averaged 12.3% (2016: 16.5%).

Figure 2: Food Inflation and its components

food inflation and parts

Source: NBS, Authors computation

The Week Ahead (November 26-30): System maturities pick-up and much ado about MPR

  • In the trading week ahead, system maturities climb to NGN593billion (from NGN409billion) split between OMO bills (75%) and NTB (25%). There will be an auction on Wednesday, where the CBN, on behalf of the FGN, will look to rollover NGN150billion worth of NTB paper split across 3M (NGN23billion), 6M (NGN25billion) and 1-yr (NGN103billion). The pick-up in system liquidity and dovish sentiments echoed at the MPC are likely to drive a modest bullish twist to debt markets this week.
  • Monetary Pointless Rate or Monetary Policy Rate: In the aftermath of the MPC meeting, some have asked what the point of MPR as many local fixed income fund managers is no longer bother trying to figure it out as it bears little semblance to the actual evolution of market interest rates. Indeed, looking at the chart below, OMO yields display a stronger co-movement with treasury bill yields than the MPR. Though open market operations have long existed in the CBN policy tool kit, its increased usage is a more recent phenomenon. Looking at data, 2011 marked the start of more frequent monthly issuance of OMO bills by monetary authorities and it marked the commencement of both an aggressive stance towards system liquidity and a tightening stance by then governor Sanusi Lamido Sanusi as it was complemented by a rate hike (MPR upped from 6.5% to 12% over an 8-month cycle). Thereafter they assumed a life of their own and since 2016 have become the defacto monetary tool with real teeth and religiously followed by market participants real teeth while the MPR has become a mere symbol beholden only to journalists and the lay man.

Figure 3: MPR, OMO and NTB yields

Source: CBN, FMDA, FMDQ. Gaps reflect periods of no OMO auctions over a month

  • In theory, policy rates work as a signaling tool of where monetary policy makers believe market interest rates should be given their expectation of the time path of policy anchors. In the US, the Federal Reserve talks of a range of where it will carry out activity in money markets based on its explicitly stated forecasts of inflation and unemployment given its dual mandate. The situation is largely the same across other central banks except with variation on the target variable (it could be real GDP growth, credit growth, money supply or exchange rates). However, in Nigeria where the CBN claims it swears by inflation on monetary policy, it does not explicitly state its forecast inflation trajectory over the next 1-year at MPC meetings or that of its other key macroeconomic variables. The absence of this information makes it difficult to guess the direction of monetary policy as one neither as in practice the CBN juggles between inflation, FX, credit growth and economic growth as pliable excuses to justify fluid policy positions. The net effect is lack of credibility across key markets and prevents formation of informed expectations and is a driver of heightened volatility in debt markets. A simple way to solve this issue is to make use of simple forward guidance.
  1. Declare at MPC meetings, the CBN’s the 1-year forward forecast of key variables of interest which in Nigeria should naturally revolve around oil prices, core inflation (defined as all items less food and fuel not the current core definition used by the NBS which includes fuel prices), CA balances, FX reserves, credit growth and the real effective exchange rate.
  2. Declare the CBN’s own comfort zone over the next 1-year (which must have some linkage to medium to long term targets). Now this distinction is clear, the closer or farther we are to the long run target the easier to declare that we are on a credible convergence/divergence path.
  3. Ensure a firm linkage between the OMO yield and the MPR. Presently, the effective OMO yield at 16.8% presents a theoretical arbitrage window as banks can lend from the CBN at 16% at invest in 1-yr OMO bills negating CBN’s desire to boost credit growth. Cut this out and make it one that is more predictable.
  4. Use a band for possible OMO rates (which can be explicitly stated) and avoid changing this band outside of MPC meetings unless under abnormal conditions dictated by the market which in itself is feedback for the next MPC meeting. This is why the US Federal Reserve uses a band when declaring its decision on the Fed Funds rate.
  5. Look towards replacing the current nominal exchange rate policy anchor with REER based one.

By providing enough data on its internal thinking process and finding a lasting workable solution around the nominal NGN peg, the CBN can credibly find a way towards improving monetary transmission to market interest rates. Continuing on the current time path relegates the importance of the MPR and the associated MPC meeting.

• OMO: Open Market Operations
• CP : Commercial Paper
• DG: Deputy Governor
• NTB: Nigerian Treasury Bill
• FGN: Federal Government of Nigeria
• CBN: Central Bank of Nigeria
• DMO: Debt Management Office
• PBoC- Peoples Bank of China
• PMA: Primary Market Auction
• FAAC: Federal Accounts Allocation Committee
• I&E: Investors and Exporters Window
• MPC: Monetary Policy Committee
• NBS: National Bureau of Statistics
• REER: Real Effective Exchange Rate

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