Nigeria Fixed Income Weekly

The Week that was (January 18-22, 2021)

The main highlight of last week was the result of the monthly bond auction, where the DMO signaled an unwillingness to pay higher interest rates for borrowings. Nevertheless, debt markets have remained fervently bearish all through the week with implied term premiums now at elevated levels. Between Nigeria’s economic managers and bond markets, someone has to be wrong on pricing of debt securities and my thoughts are that bond market bears may be pushing their luck.

DMO ‘undersells’, but relies on non-competitive bids:  At the maiden bond auction for 2021 where the Debt Management Office (DMO) put up NGN150billion worth of bonds on offer, demand of 1.6x (Dec: 2.2x) showed up but unknown to bond markets, there were non-competitive bids (NCBs) of NGN48billion waiting in the wings. The large NCBs amount implied a total bid-cover ratio of 1.9x and allowed the DMO borrow a much higher NGN170billion at average marginal rates of 8.56% (December: 6.97%). Relative to secondary market levels where yields have climbed 130bps YTD, the DMO positioning on rates appears largely market neutral. At 28% of 2020’s number, the strong start in NCBs alongside the potential NGN805billion under the newly established Unclaimed Dividends and Dormant Account Balances Trust Fund, it would appear that the DMO has some arsenal to ‘manage’ bond auctions over 2021.

Figure 1: Non-competitive bids

Source: DMO 2021* January 2021

But bearish sentiments continue to dominate trading: Despite the fact DMO left more money on the table with large rejected bids at the long end, bond markets remained bearish as yields closed the week up 32bps on average. The sell-offs on the long end comes despite under-allotment at the segment at the auction which ordinarily should have induced a moderation at the segment.

Figure 2: Naira Yield Curve

Source: FMDQ, NBS

This suggests two things: firstly, a lot of demand at the auction was largely speculative (losers were merely trying their luck) and that the bearish sentiments reflect an overhang of genuine sellers at the secondary market. On the latter, it is important to remember that in November PENCOM issued a circular which imposed a four month deadline (February 4) on pension fund managers to clear out their excess MTM bond positions relative to regulatory limits. As the deadline looms amid a shortage of bids, these pension funds (who received another reminder over the week) are likely to be more desperate to sell regardless of whatever developments in the macro environment. Throw in the odd bond market shorts looking to profit on the prospect of higher bond supply, it become easy to explain the sustained pressure along segments of the curve (especially 2034s and 2049s) which has pushed average term premiums to record levels.

Figure 3: Average Term Premiums

Source: Authors computation

High term premiums often incorporate uncertainty about the future and a strong run-up usually provides a hint about a possible inflection point in the rate cycle. In this case, the present surge in term premiums would seem to suggest that interest rate tightening is underway or imminent but as developments over the last one week (NTB auction, bond calendar, bond auction) would suggest, this is not the case per the fiscal side. And as we are likely to see next week, the first MPC in 2021, the CBN is unlikely to evince any hawkish signals. If this holds, then one can arrive at two conclusions: 1) that the current bearish run largely reflects exit of desperate sellers (helped by some shorts) 2) Post the PENCOM deadline, bond markets are susceptible to a bullish correction all things held constant.

The Week ahead (January 25-29, 2021)

Into the last week in January and focus shifts to the CBN as it commences the first two-day monetary policy meeting of 2021. My guess, as with the market, is for a retention of status quo with some dovish commentary. There will be an NTB auction, where the CBN would look to roll-over NGN187billion maturities. Maturities remain robust with bond coupons (NGN88billion) and OMO maturities (NGN190billion) which should see a well-bid NTB auction.

A dovish MPC on the cards: At the inaugural MPC for 2021, the economic environment is little changed from that in November. Nigeria’s economy remains under the COVID-19 induced recession with the much feared second wave largely underway (with prospects for a re-imposition of movement restrictions). This suggests any rate tightening is premature despite inflationary concerns. The current inflationary bout is largely driven by soaring food prices (a situation not unique to Nigeria) which reflects the shocks to food production due to disruptions from COVID-19. Nearly all countries along the West Africa are reporting elevated food inflation with subdued core prices and global food prices are at multi-period highs. The much weaker core inflation prints suggest much more muted inflationary expectations despite shocks to the currency, fuel prices and electricity tariffs. As such once the base effects kick-in, we are likely to see a faster disinflationary run in H2 2021. On the currency front, oil prices are back to pre-COVID lockdown levels and planned Eurobond issuances could provide relief to sort out capital account pressures. Under these settings and with its CRR tool for curbing excess liquidity in the banking system, there is little incentive for the CBN to nudge interest rates higher.  

Figure 4: MPR and Average FGN Bond Yields

Source: CBN, FMDQ

Abbreviations

  • CBN – Central Bank of Nigeria
  • DMO – Debt Management Office
  • NTB – Nigerian Treasury Bills
  • OMO – Open Market Operations
  • MPC – Monetary Policy Committee
  • PENCOM – National Pension Commission
  • MTM – Mark-to-Market
  • YTD – Year-to-Date
  • NCB – Non-Competitive Bids

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2 comments

  1. Aghogho onoro · · Reply

    Spot on Analysis!
    However I have few questions.
    With the FGN Bond – Secondary Market. There was a slight up tick in the Bond Yield when comparing yields today yields with December’s performance. However the article reads a bearish bond performance.

    1. There is an inverse relationship btw bond yields and bond prices. When yields are rising bond prices are falling and when falling bond prices are rising. So when rates are rising, its a bearish price trend.

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