The week that was (August 9-13)
Banking system liquidity conditions appeared less loose relative to the prior week with a pick-up in bank borrowing from the CBN’s discount window which kept interbank borrowing rates slightly elevated (16-17%). Nevertheless, rates declined across the Naira yield curve amid fresh weakness in the Naira at the parallel market. FX reserves tracked higher and tax data showed a recovery from the covid-19 impacted base of 2020.
Robust demand at the PMA sees further drop in NTB yields: At the fortnightly NTB auction, where the plan was to rollover NGN51billion, the DMO sold NGN156billion implying net issuance of NGN105billion with stop rates were unchanged for the 3M (2.5%) and 6M (3.50%), while the 1yr bill slid 85bps to 7.35%. Though bid offer was high at 7.7x for the auction, this reflects the low amount on offer as absolute bids were lower on the 1-yr (NGN387billion vs NGN440billion at the prior auction).
Figure 1: Auction Demand for 1yr NTB in 2021
The oversale at the auction implies that the DMO has net issued NGN654billion worth of NTB debt thus far in 2021. Bear in mind that in January 2021 when yields were at 2%, the DMO net repaid NTB maturities to the turn of NGN103billion so what is informing this turnaround. My suspicion is that the recent round is likely being used to fund the NGN561billion FGN bond maturities. However, this is a high-risk debt sale strategy as these net issuances raise potential front-end paper supply when these instruments mature, greatly increasing rollover risk over 2022 (which is exactly the opposite of what the 2018 Eurobond for NTB refinancing plan was designed to reduce). As liquidity from the July maturities thin out and as yields slide lower, I expect demand pressure at the NTB segment is likely to moderate.
Bond yields compress further on short-covering and Eurobond speculation: Sentiment trailing the National Assembly and FEC approval of NGN2.3trillion (USD6.1billion) worth of Eurobonds continues to reverberate across bond markets. The dominant theme which has emerged is that a successful Eurobond sale will drastically reduce domestic supply of bonds. This prospect has triggered another round of short-covering by banks and bullish positioning by local asset managers (including some offshore action) with the result being a 30-45bps average decline in bond yields. The trade essentially is to buy at the going rate on the hope that as FGN paper supply shrinks, domestic institutional investors will be around to buy bonds later in the year at lower levels. Whether this will work out as the bulls’ hope is a different kettle of fish but that appears to be the reasoning behind the trade.
Figure 2: Naira Yield Curve
In framing my outlook I would like to point out two quotes by John Maynard Keynes, “…markets are moved by animal spirits, and not by reason” and “successful investing is anticipating the anticipations of others”. It is very possible for debt markets to filter out actual reality and rally on this Eurobond displacement of local borrowing sentiment. However, this trade is being dominated by short/speculative money positions (including the lily-livered offshore investors) all betting that demand by real money accounts will close out the trade. This view ignores the implication of the seismic shift in pension fund regulation around treatment of bond classifications. As we saw in April-May, sell-offs could be overdone. Who will be the first to pull the trigger? Don’t be the last man out!
Tax collection data point to a recovery in fiscal receipts: The NBS put out half-year data on value-added and corporate income taxes which showed a 55% and 24% y/y increases across both items to NGN1.01trillion and NGN865billion respectively. Relative to the budget, the two items are tracking at 55% (VAT) and 58% (CIT) and provide evidence of that the removal of lockdowns has driven a recovery in business activity and corporate earnings from the covid-19 impacted base of 2020.
Nigeria weakens at the parallel market: FX reserves continued to rise, up 0.5% w/w to USD33.58billion though IE window turnover dipped (2.4% w/w to USD137million). For the exchange rate, the Naira softened at the parallel market to NGN515/$ but continued to hug the NGN410-411/$ handle at the IE window. All eyes now on the SDR injection later in August and the USD6.1billion Eurobond sale possibly in September or October 2021 which should provide a direct injection to external reserves.
The week ahead (August 16-20)
In the week ahead, system maturities are made up of NGN91billion in OMO bill maturities and NGN260million in FGN Savings Bond maturities. The uptick in OMO bill maturities could yet induce an OMO auction. Money market rates are likely to pick-up as bond auction and FX sales debits are passed through the system. In terms of events, the NBS is scheduled to release July 2021 CPI on Monday though market focus is likely on the outcome of the monthly bond sale on Wednesday.
July 2021 Inflation to show further moderation due to base effects: After spiking in Q1 2021 to 18.2% y/y, inflation has decelerated to 17.75% y/y at the end of Q2 2021, largely on account of the so called ‘base effects’. The monthly run rate has also slowed from 1.53% in the first three months of 2021 to 1.01% over the April-June period. Looking at price trends over July, open market surveys by AFEX point to a drop in food prices during the month which suggests that early harvests have started to filter through which likely weighed on food CPI. Nevertheless, energy pressures are likely to have appeared as Naira weakness appears to have feed-through to cooking gas, diesel, and kerosene where prices moved through the gears in July. As such, my projection is for monthly inflation in the range of 1.05-1.11% which spits out a headline number around 17.5-17.6% y/y.
Figure 3: 2021 Inflation Outlook
Source: Authors calculation
Over the rest of the year, outlook is for further declines driven by a combination of much better food harvests, as cultivation activity stabilizes after the covid-19 disruptions, and large base effects. On fuel prices, last week the FGN rejected another request by the state governors for increments to PMS prices to reduce the subsidy burden which suggests limited appetite to raise prices over the near term.
August 2021 Bond Auction: On Wednesday, the DMO has put up its usual NGN150billion offer split across the 2028, 2036 and 2050 tenors. In setting out my views it would be good to see where the numbers stack up. Thus far in 2021, the DMO has sold NGN1.66trillion worth of bonds though adjusted for the NGN561billion in bond maturities implies net bond sales of NGN1.1trillion. As noted earlier, net NTB sales from my calculations stand at NGN654billion implying net domestic borrowings thus far at NGN1.75trillion or 75% of the 2021 domestic borrowing plan. However, with presidential assent in July, the supplementary 2021 includes NGN805billion worth of extra borrowings which lowers implementation rate of domestic borrowings from 75% to 56% with five months left in 2021. It is important to note that the 2021 budget envisaged a fiscal deficit of NGN5.6trillion to be financed via total borrowings of NGN4.7trillion split evenly between domestic and foreign sources at NGN2.3trillion apiece. The theme in debt markets appears to posit that a NGN2.3trillion foreign sale will render invalid the untapped component of the NGN2.3trillion domestic target. Clearly this is unlikely to be the case and the event of Eurobond sale of less than USD6billion is likely to unravel that view. Moreso it forecloses the supplementary NGN805billion new borrowings.
What does all this mean? it seems clear is that the talk about the potential death of DMO’s appetite for local borrowings post a successful sale of USD6.1billion in Eurobonds appears exaggerated. Following the recent moderation in yields, I expect the DMO to be open to taking up bonds at the auction with a target of at least NGN200billion. With regards to demand, my suspicion is that demand could be inflated by shorts looking to cover their positions and players looking to open fresh speculative positions, so my sense is demand is likely to recover after the slump in July. In all, my expectation is for the auction to close as follows: 2028 (11.9-12), 2036 (12.80-12.9) and 2050 (12.95-13.05). As in July, the DMO is likely to deploy non-competitive bids which set to be the second highest annual levels.
Figure 4: Non-competitive bids
Source: DMO *2021 is January-July.
CIT: Company Income Tax
DMO: Debt Management Office
FGN: Federal Government of Nigeria
FMDQ: Financial Market Dealers Quotations
OMO: Open Market Operations
NBS: Nigerian Bureau of Statistics
NCB: Non-competitive bids
NTB: Nigerian Treasury Bills
VAT: Value Added Tax