The weeks that were (March 5-March 19, 2021)
After the sell-off at the long end in recent times, action has been on the front end of the curve where interest rates have climbed recently. On the macroeconomic front, data releases have been mixed with inflation continuing its upward climb while unemployment surged to record highs.
From steepening to the start of an inversion? Since my last update the Naira yield curve has climbed on average 49bps (YTD: +377bps) driven by a sell-off on the front-end (+188bps) relative to an average 10bps increase in bonds. The rise in short term interest rates reflects two developments in the T-bill space where firstly, tight financial system liquidity occasioned by a mix of CRR debits, thinner OMO maturities and FX auctions have worked to drive money market rates higher. Crucially, the liquidity squeeze has forced banks to dispose of their holdings of the 90-day CBN Special Bills (SPEBs) at levels between 5-6% which implies mark-to-market losses on these positions. Secondly, the CBN (on behalf of the DMO) has consistently raised clearing rates for the 1-year NTB at the primary auction by 50bps to 7% at the last sale, while leaving yields on the 3M and 6M bills unchanged at 2% and 3% respectively. The appearance of these bills has provided an outlet for institutional investors to bid up placement rates which have climbed progressively from 1-2% at the start of the year to 5-6% while OBB/Overnight rates surged to 25% levels. For bonds, as I noted the disappearance of desperate pension fund offers helped calm markets and recent uptick appears to reflect short positioning ahead of the bond auction next week with sell-offs across 2034s and 2049s mirror instruments for the auction papers (2035s and 2045s).
In summary, it looks like we are at the start of another Naira yield curve inversion cycle that would see short term interest rates in particular, the 1year NTB rise progressively to 10% (effective yield of 11%) just around where the MPR is nestled. Depending on how the bond auction goes, specifically if the DMO under-allots to the market relying on competitive bonds, further upside in bond yields might be capped while the short end moves to re-store the long historical norm of an inverted yield curve.
Figure 1: NGN Yield Curve
Source: FMDQ, NBS
Inflation tracked higher in February, lean season pressures underway: The Nigerian Bureau of Statistics (NBS) revealed that headline inflation accelerated to 17.33% (January: 16.47%) vs my forecasts for 17.11%. As with the pattern over the last eight months, the key driver remained food inflation (21.8%) relative to more muted patterns in core inflation (12.38%). However, the monthly inflation (which ideally should be the focus of what is happening, as the headline number falls prey to the base effect) showed an uptick to 1.54% (January: 1.49%), a reversal of the dip seen in prior month. Looking at the sub-parts, an uptick in farm produce in rural Nigeria (vs. a dip observed across urban Nigeria) drove the food pressures.
Figure 2: Inflation trends
Some context here, Nigerian food prices tend to be driven by developments around the crop harvesting cycle with the main harvest which typically starts in August/September and runs till January/February usually associated with seasonal downtrends in prices. If crop production is exceptionally strong across Nigeria then the harvest impact drives prices really low and vice versa. There is a lean season which is associated with when households have largely depleted their harvest stocks and are more reliant on market supplies. Usually this runs from March/April and runs till June/July and is often associated with a seasonal uptick in prices. Given the bad harvest in 2019/2020 crop cycle, more households in rural Nigeria have rundown their crops and are now applying more pressure on markets which is driving prices higher. This situation is worsened by poor crop harvests across West Africa as COVID-19 lockdowns hurt cultivation activity in 2020.
Throw in the rebound in fuel prices and it’s fairly easy to see why inflation has some leeway to run over 2021. As we head into the lean season (the March-June period), farm produce prices are likely to track higher fuelling further rises in food inflation. Furthermore, following a 30% rise in global crude oil prices in February, prices of deregulated petroleum products (diesel, kerosene and gas) look set to rise higher while it is only a matter of time before the government adjusts petrol prices higher (likely over NGN200/litre vs. 2020 average of NGN147/litre). My range of plausible average inflation forecasts runs anywhere between 17.4-18.4% (2020: 13.2%). The big risk in my outlook relates to insecurity issues.
Figure 3: Forecast headline inflation trajectory over 2021
Figure 4: 2021 Average Inflation Forecast Range
Source: Authors calculation
Unemployment surges: The NBS also dropped Q4 2020 unemployment numbers which showed another surge in the unemployment rate to a record 33.3% (Q2 2020: 27.11%). Looking at the underlying pattern, labour demand remains thin for individuals without any educational qualifications (who account for 30% of the labour force) and those with at least secondary school diplomas (32% of the labour force) as the unemployment in these two groups printed at 28.4% and 37% respectively. More worrying, labour force participation continued to fall (down to 57.1% from 68% in Q2 2020 and from the 70-78% trend level) with some 52million Nigerians have dropping off the jobs market likely due to the COVID-19 pandemic. Adjusted for these exits, the unemployment numbers understate the reported reality.
What to make of it? Some of the uptick reflects the impact of the COVID-19 lockdowns in sectors of the economy where physical interaction is unavoidable such as hotels, restaurants and a lot of the informal sector. As when you apply the ILO screen to the numbers, the unemployment rate falls to 9.8% for individuals with no qualification and 22.9% for those with at secondary school qualification. This suggests low opportunities for work likely associated with the lockdowns and social distancing.
However, the more structural issues of not enough jobs being created (i.e. low labour demand) for the low skilled workers who dominate Nigeria’s labour force (82% of the labour force). As I noted in an earlier article, Nigeria needs to focus on creating low-skilled labour intensive jobs in sectors such as agro-allied processing, business process outsourcing, call centres, construction and security services to mention a few. For all its low productivity demerits, agriculture will continue to provide a temporary second-best outlet for these workers, but over the medium term Nigerian policymakers will need find a way to boost output per worker with high yielding crop and animal breeds, better agriculture extension services, increased investment in irrigation and storage and soil nutrients.
Mixed trends in money supply data for January, CBN tightening? Latest money supply data for January 2021 shows an annualized 7.1% contraction in broad money (M3) while other monetary aggregates expanded: M2 (+1.3%), M1 (+0.2%) and M0 (+15.8%). The drop in M3 (defined as M2 + CBN bills) reflects a reduction in CBN bills (down 15% from year end 2020) which is consistent with net OMO bill redemptions over the period. Some fuel to the CBN exit from OMO strategy perhaps? However, as always CBN is all about give and take and the liquidity freed up from the OMO bill redemptions were taken back via CRR debits whose cumulative balance climbed 29% to NGN10.1trillion. The last point explains the movement in base money (M0) while net NTB repayments account for the uptick in M2. In all, the inference from M3 is that the CBN tried to keep a tight lid on the expansion in money supply while it continued unwinding its OMO book.
The Week ahead (March 22-26, 2021)
In the week ahead, system maturities are thinner relative to recent trends with only NGN50billion in OMO maturities on Tuesday and FGN coupon inflows of NGN15billion. Market focus will switch to the second MPC meeting in 2021 as well as the March bond auction slated for Wednesday.
Tightening on the cards: With Nigeria’s exit from recession, rising inflation expectations (outlook is for a shift 18-19% in the near term) plus the need to increase the rewards for holding Naira (i.e. curb USD demand) will assume priority within the CBN. That said, two confounding factors could potentially muddy a progression towards tightening. Firstly, economic growth outlook remains precarious (as the unemployment numbers reinforced) and the possibility of a double dip (given regulatory actions curbing telecoms) cannot be ruled out. Furthermore, the FGN has a sizable borrowing requirement which includes conversion of NGN10trillion worth of CBN financing into bonds. These two factors will require some passage of time to get clarity which suggests the May 2021 MPC (over this month’s MPC) as the suitable time for monetary tightening. However, as we saw in September 2020 when MPC members overruled the Governor, there is an outside chance, that the ‘rebels’ could press for tightening and win at this meeting. Over 2021, my revised expectation, in the event we avoid a contraction in Q1 2021, is for the CBN to ramp up the monetary policy rate towards 14-15% levels. If we have a contraction, the CBN is likely to dial back on any tightening.
DMO to continue under allotment pattern: At the March bond auction, the DMO will look to sell NGN150billion via re-openings of the 5-year (2027) 15yr (2035) and 25-yr (2045). This is likely going to be a well bid auction given the amount of liquidity milling around non-bank financial institutions and reluctance of these buyers to engage bonds in the secondary market. Given that the 2027 and 2035 are trading at premium to par and the 2045 are at discount, the DMO is likely to over-allocate to the former and less to the latter given that it reaps more in cash terms. As with the earlier auctions in 2021, the DMO is likely to continue to deploy its non-competitive bids, given the finance bill approvals for unclaimed dividends and dormant bank accounts which estimates place at over NGN800billion.