The weeks that were: (Feb 10-14): Liquidity deluge drives interest rates lower, CBN defensive action on FX gathers steam
- The mammoth February maturities push rates south: After the CRR debits drove yields higher in the prior week, system liquidity improved as inflows from the FGN 2020 bond (NGN606billion) and OMO bills (NGN517billion) helped drive compression in overnight borrowing rates with the OBB/OVN both down 1200bps to 2.5%/3.25%. Across the curve, the impact of the liquidity deluge was evident as NTB yields declined 13bps on average to 2.6-4.3% while bond yields 6bps to 6.9-12.3%.
- At the NTB auction, where the CBN, on behalf of the FGN, offered NGN154billion (relative to maturities of NGN147billion) demand remained strong with subscription rate at 1.9x (N289billion). However, in a sign of growing market sensitivity, the 1-yr stop rate inched up 4bps to 6.54% though declines were observed across the other tenors due. At the OMO auction where the CBN had NGN250billion on offer, subscription was weaker at NGN215billion with the auction closing at a discount of 13.04% (effective: 14.9%).
Figure 1: Naira Yield Curve
Source: FMDQ, NBS.
- Eurobond noise gathers steam, but debt mix presents problems: Talk around a potential Eurobond has picked up in recent days with the spokesman of the Finance Minister talking to Bloomberg about plans to tap global debt markets for anywhere between USD2.8-3.3billion. Though the DMO tried to temper talk around this plan in January, currency concerns appear to be pushing the FGN to explore this option given the low rate environment on the Naira side. DMO reluctance at selling Eurobonds possibly reflects the fact that interest expense on Nigeria’s FX debt now exceeds USD1billion (9m 2019: USD1.03billion) which implies the size of future sales have to much bigger in scope.
Figure 2: Nigeria – External Debt Composition
- CBN introduces 5-year NDF, FX curbs on milk imports: FX market activity was robust over the week with an 18% rise in average daily turnover to USD389million (Total over the week: USD1.9billion). Nevertheless, the downtrend seen in FX reserves continued (-1.1% w/w to USD37.2billion, YTD: -3.5%) reflective of the external account imbalance brought about by lower oil inflows and higher imports. The downtrend would seem to be inducing defensive moves on the part of the CBN, which started with the ban on FX for fertilizer imports which has been extended to milk imports (except for six shortlisted diary producers). Rounding up the activity on this front was the announcement on Thursday that the CBN would now offer Naira settled OTC FX futures of up to 60-months (5-years). As the first prices rolled off the ticker tape, the question was what the pricing would look like. Perhaps not too surprisingly, the CBN appears to have used much lower NGN interest rates (than those along the yield curve) in pricing the forwards. To appropriately the price these instruments, the CBN would have offered a price which used the risk-free rate along the various tenors of the NGN yield curve. But it appears to have used much lower interest rates than the current curve which leads to very different outcomes.
Figure 3: NDF pricing and implied NGN devaluation
Source: FMDQ, Authors computation
- Using the quoted rates, the CBN seems to be saying expect only a 4% Naira devaluation over the next five years as against a 9% outcome using the differential between FGN bond yields and US Treasuries of comparable tenors. For comparison, the 15-year FGN closed Friday at approximately 10% but the CBN appears to be saying the implied yields is less than 1% looking at the NDF forward. I think the CBN is trying to signal a cheap hedging option for existing foreign portfolio investors as a way to cultivate their interest in rolling over OMO bill maturities. Though FX spot prices remained under pressure, the cheaper OTC futures appear to have impacted the forward market where the 6m and 1-yr forward rate appreciated 1.2% and 2% respectively.
- Would offshore investors pile into the new NDF tenors and associated instruments on the NGN curve? This answer would be in the affirmative if the NGN yield curve were offering real returns and foreigners could see headroom for a duration chase. But under current conditions and alongside continued foreign access to higher yielding OMO bills, my suspicion is that the more closer tenors (possibly up till the 2yr) are essentially a cheaper means of buying devaluation protection. Foreign money is likely to purchase the tenors up until 2-years as a means of hedging exposure to 1-yr OMO bills for easy rollovers without having to buy these OTC futures again. This is a non-trivial outcome given the large offshore maturities and OTC futures which mature over February-March. That said, the low oil price places a high hurdle of concern over NGN exposure and I doubt the downtrend in FX reserves and elongated OTC futures will provide comfort about the potential for a disorderly breakdown in FX markets.
The Week ahead (Feb 17-21): Liquidity to weigh on rates across the curve and higher inflation
- In the week ahead, system maturities remain large with OMO maturities at NGN627billion. The monthly bond auction takes place on Wednesday where the DMO will have NGN140billion on offer across three maturities (5yr, 10yr and 30-yr).
- January Inflation outlook: The National Bureau of Statistics (NBS) looks set to release the first inflation prints of 2020. With VAT increases effective in February, I think the January numbers are likely to reflect the lingering impact of the border closures. My guess is for the headline inflation to print at 12.2% y/y with a monthly print of 0.9%. Inflation is likely to track higher in coming months as the VAT increases kick-in from February with more upside in the event of increases to the electricity tariff over 2020.