Nigeria Fixed Income Weekly

Happy Holidays and I must apologize for the two-week radio silence as I had to take a break from work to relax after a long hard year 😊 regular programming is back!

The Week that was (December 10-28): Despite a hawkish CBN posture, yields moderate in response to a miserly DMO and still ‘excess liquidity’

  • CBN resumes usage of ‘gestapo’ tactics in curbing liquidity: In response to currency pressures at the parallel market at the start of December, the CBN adopted a low tolerance for excess Naira liquidity in the financial system by increasing the frequency of OMO auctions and hiking the discount rates to 15% (effective: 17.5-7%) for the 1-year OMO bill. Consistent with this posture, the CBN ensured that weekly OMO issuances were in excess of weekly OMO bill maturities ensuring it was in effect net withdrawing liquidity from the system. However, over the last three weeks, despite offering NGN1.4trillion which is typically in sync with CBN estimates of OMO bill maturities and excess system liquidity, the apex bank was only able to sell NGN540billion (38% of the offer). In response to the low demand at OMO auctions, the CBN turned dictatorial with the resort to forced sales of 1-yr stabilization securities (STABS) which netted NGN841billion. This resulted in a seeming paradox across money markets as while overnight/OBB rates remained fairly high at 27.5/29.8% (which is suggestive of tight liquidity in the banking system), the wider non-banking public awash with excess cash was forced into short-covering which drove treasury bill yields lower.  Specifically, NTB yields plunged over 181bps over the last three weeks to 12.6% and 13.4% for the 3M and 6M tenors. Only the 1-yr NTB survived holding at 17.33% as the CBN continued to reinforce the notion of above 17% for the tenor.
  • Again, DMO calls bond market bluff, sending bulls into overdrive: For the second month in a row, the DMO adopted a miserly posture at the monthly bond auction with the sale of only 8% of its intended NGN70billion on offer at an average yield of 15.42% (November 15.5%). The amount sold is the lowest ever allocation ratio on record and comes amid more robust demand at the December auction with bid-cover of 1.34x (November: 0.9x, October: 1.25x). This is consistent with the view I echoed following November’s Eurobond sale, that bond markets which had turned bearish in response to CBN tightening at the short-end were likely to be wrong-footed by a more cash buoyant DMO. Given its cash rich position and in view of robust demand for Sukuk II, the DMO decided the call the bluff of the bond market bears at the auction by rejecting most bids. Consequently, the auction losers turned bullish to cover their positions particularly with the 10-year bond (yield declined 68bps). In all, following the auction, FGN bond yields nose-dived in secondary trading (down 20bps on average) to 15.2-15.74%.
  • Sukuk II oversubscribed: In between, the DMO announced a successful closure of the NGN100billion Sukuk II bond with the receipt bids of NGN125billion for the 15.74% 7-year paper on offer. This higher bid-cover ratio for the 2018 sale (1.25x) relative to the 2017 debut issue (1.05x) suggests that the DMO has been successfully able to crowd-in a new class of bond investors with a specific focus on Islamic financing. My suspicion is that we might see a larger tranche for the 2019 program.

Figure 1: Naira Yield Curve

NGN yield curve dec 30

Source: FMDQ, NBS

  • Round-up of Macroeconomic Data releases: November Inflation printed at 11.28% y/y (October: 11.26% y/y) which is consistent with a going nowhere view of inflation in the absence of any significant movements on fuel price and the exchange rate. Q3 2018 GDP growth printed at 1.8% y/y (Q2 2018: 1.5% y/y) as despite further signs of progress on non-oil output which expanded at its fastest pace post-recession (Q3 2018: 2.3% y/y) continued contraction in oil output with average oil production of 1.84mbpd (vs 1.98mbpd in Q3 2017) ensured the slack pace of growth continued. Lastly, the NBS released macroeconomic data showing that unemployment climbed from 23.1% in Q3 2018, up from 18.8% in the prior year largely reflective of a new entrants into the labour force finding it harder to get new jobs. All three data points should naturally carry dovish implications for monetary policy, but the CBN is likely to claim these are structural issues requiring fiscal policy medications to justify maintaining a hawkish monetary policy stance. This would be consistent with current account data over Q3 2018 where despite stronger oil prices, Nigeria posted a deficit of USD3.11billion (3.3% of GDP) as higher imports of drilling equipment combined with wider services imports and income outflows. Specifically, non-oil imports linked to the Egina oil field which arrived in Nigeria in 2018 and were booked in Q3 drove the surge in overall imports.

Figure 2: Current Account balances (% of GDP)

CA q3 2018 chart

Source:  CBN

The Week Ahead (December 31-January 4): Happy new year! and a higher interest rate outlook beckons in 2019

In the three and a half day trading week ahead, system maturities fall slightly to NGN540billion split between OMO (79%) and NTB (21%). There will be an NTB auction on Wednesday, though the DMO would only redeem 27% of the NGN115billion maturity over the week in line with the notice in December to part redeem NGN84.5billion. This would imply that the CBN would continue the raft of OMO and STAB sales to curb system liquidity.

2018 was a year which the external environment (read oil prices) was largely supportive of Nigeria’s internal macroeconomic situation and this allowed the FGN lower its domestic borrowing activity. Consequently, the key driver of interest rates was the CBN’s response to fluid market sentiment over the exchange rate given the turmoil across emerging/frontier markets due to US Federal Reserve tightening. Inflation was largely benign as they key troublesome supply side issues (fuel, electricity and exchange rate) were largely stable. Accordingly, interest rates ebbed over most of H1 2018 before climbing in the latter half.

Going forward, Nigeria’s debt markets will need to navigate sizable political and monetary policy uncertainty over the first half of 2019 under an atmosphere of weaker oil prices. This likely dynamic picture and CBN’s commitment to hold the Naira stable implies that interest rates are likely to climb over most of the year especially along the front end. Till then, Happy New Year in advance and good luck with the trades in 2019.

Abbreviations

  • 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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