The week that was (August 20 – September 3)
Since my last update, interest rates across the Naira yield curve have headed further south over August as the maturity hangover from July (and CBN’s continued tolerance of excess liquidity) induced a bid-up in the prices of fixed income instruments. Initially this buying was led by a mix of banks, domestic fund managers and offshore investors, but more lately by some pension funds per word on the street. Elsewhere, rising FX reserves following the SDR receipt, the Naira continues to fall at the parallel market as the CBN’s dollar supply remains patchy. On the macroeconomic front, thanks to base effects, Nigeria’s economic growth surged over Q2 to its highest in 5-years with a 5% print while money supply data showed that the CBN remained coy on system liquidity over July.
Robust liquidity conditions driving lower front-end yields: Front-end rates declined over August reflecting robust liquidity conditions, a fall-out of the large July bond maturity (NGN561billion) and large coupon inflows as well as CBN’s decision to cease OMO bill auctions until late August. The build-up in system cash positions forced changes in investor behaviour across debt markets. For banks, faced with limited investment outlets and possibly reduced appetite for lending, they appear to have ramped on purchasing securities (initially NTB instruments and later on bonds) as a way to reduce cash positions to minimize the risk of CRR debits. Offshore investors followed suit as with no OMO instruments to buy they quickly switched to NTB papers and after those yields dropped to single digits began dabbling into front-end bonds. Demand from these groups of investors appears to explain the robust bidding at NTB auctions which forced yields lower, with auction yields on the 1-year down to 6.8% from 9.2% at the end of June 2020. As money supply data would later reveal the CBN appears to have tolerated the build-up in excess liquidity as its securities holdings dropped sharply over July (down 97%).
FGN bond yields head south spurred by bank-led buying: Despite the recent resumption of OMO auctions, FGN bond yields resumed the fresh bullish bias as the large coupon profile over the next two months (September: NGN301billion, October: NGN201billion) presents another window for technical trades. Looking at the curve, the front-end (1-5yr) has seen larger compression (-177bps) relatively to the mid (5-10-yr) and long (> 10year) segment where yields have tumbled 111bps and 83bps respectively. This is testament to who the main buyers of the current rally are: duration averse short money buyers in search of yields. As the compression in front-end yields widened the spreads between maturities, it worked to induce bond buying on the long-end to narrow the spreads.
Figure 1: Naira Yield Curve
CBN rolls over SPEBs, introduces shorter maturities: The CBN rolled over NGN3.5trillion worth of 31-August Special Bills (SPEBs) for another three months at the 0.5% level. In addition, the apex bank introduced two new tenors: 35-days (NGN500billion) and 64-days (NGN500billion) at yields of 0.3% and 0.4% respectively. Essentially the CBN appears to be saying that it remains keen on capping system liquidity but will not be footing the tab as with high-yielding OMO bills in times past. The decision to introduce shorter maturities could be an attempt by the CBN to smoothen the out the potential impact of the large rollovers into a more manageable profile.
Money supply data shows that CBN aggressively eased over July: CBN released data on money supply trends in July, which showed an extension of the pattern in June, when the apex bank eased up on liquidity tightening. Though the main monetary aggregate (M3) expanded only slightly (+0.95% annualized) as at the end of July, liquidity conditions eased over the month. Specifically, CBN bills outstanding bills declined 97% m/m or in simple terms the CBN allowed NGN628billion of bills to mature uncontested (given that it suspended OMO bill sales). This liquidity release alongside bond maturities spurred a pick-up in quasi-money (i.e. time and savings deposits) which jumped by NGN716billion over July and spurred an expansion in M2 (+9.4% annualized). Though CRR debits continued over the month, the absolute quantum remained soft (+NGN426billion increase over July to NGN10.1trillion). Overall, monetary policy was remained accommodative over July which underpinned for the moderation in interest rates over the period.
SDR injection drive FX reserves higher, but Naira slumps at the parallel market: After moderating in the lead-up to the August 23 date for the receipt of USD3.3billion IMF SDR injection, Nigeria’s FX reserves have quickened ever since, up to USD34.2billion. This number, which is a 30-day average should gravitate towards USD36-37billion by the end of September. Nevertheless, the Naira continued to weaken at the parallel market dropping to NGN530/$ with the gap over the official now over NGN100/$. This persisting divergence poses risks to the entire macro stability and needs a solution.
Growth accelerates on base effects: The National Bureau of Statistics (NBS) released the Q2 2021 GDP report which showed that Nigeria’s economy expanded 5.01% y/y largely reflecting base effects from Q2 2020 when output sank 6.1% y/y. Breakdowns show the non-oil sector bounced 6.7% y/y driven by strong growth in Trade (+23% y/y), manufacturing (+7.6% y/y) and Services (+4.5%) while oil GDP remained mired in recession (-12.7% y/y) as Nigeria’s oil output averaged 1.61mbpd (Q2 2020: 1.82mbpd). On the latter point, note that the NNPC has updated the Q1 2021 which come in at 1.62mbpd vs the 1.72 the NBS used as its estimate for Q1 2021. Though some have attempted to patch this as compliance with OPEC+ quotas, there has been some chatter that Nigeria having output struggles. Something to keep an eye on. Overall, the rebound in trade and manufacturing and the resilience in telecommunications (despite the negative trend in subscriber growth) helped offset the weakness in oil output. Over the rest of 2021, headline growth should now move towards 3% though the Q2 print is likely to be the apogee.
Figure 2: Non-oil output growth attribution
Figure 3: Telecommunications GDP growth vs Subscriber Growth
Source: NBS, NCC
The week ahead (September 6-10)
In the week ahead, system liquidity will remain supported inflows from OMO bill maturities (NGN170billion) and NGN138billion in NTB maturities which implies NTB and OMO auctions on Wednesday and Thursday.
Market focus will likely be on the outcome of the NTB sale which is the first since CBN resumed OMO auctions with the 1-year stop rate. Will we see a repeat of the pattern in H1 2021 where the DMO tries to drive a convergence between the NTB and OMO stop rates for the 1-year tenor? As I noted in earlier posts, the DMO has completely torn up the script on NTBs with over-sales on the 1-year tenor since June after first redeeming at the segment in January and crucially after selling Eurobonds in 2018 with the stated aim of reducing NTB outstanding.
What is the direction for bonds? In framing the outlook for the yield curve, it is pertinent to note that bond prices are being bid-up by banks and traders focused on the confluence of a pick-up in coupons over September and October and that a Eurobond sale will drive a reduction in bond supply over Q4 2021. The latter point is really a ‘buy the rumour, sell the story’ trade and if anything, the re-sizing of the planned Eurobond sale to USD3billion vs. USD6.1billion should diminish any confidence about this point. However, the former point is worth examining as sizable coupon inflows could push bank placement rates into single digits if left unchallenged by the CBN. The return to OMO sales and an extra NGN1trillion in sales by the CBN suggests that while the apex bank is uncomfortable with the level it either not ready to move aggressively or does not possess the tool-set to execute this action under its current heterodox settings. My suspicion is that the CBN will need to clarify its game plan around normalizing interest rates at either this month’s MPC (which interestingly predates the monthly bond auction) or November’s MPC. In terms of macroeconomic outlook, inflation should head further south over Q4 2021 on base effects while a similar dynamic will keep economic growth at 4-5%. However, developments on FX front suggest all is not well in paradise with continued widening in the parallel market premiums. Looking at Nigeria’s history, fixing this issue requires a lot of dollars (which the CBN will likely get with a Eurobond sale in October) and raising short-term interest rates by draining the financial system of liquidity. These actions will provide the policy space required to deal with the FX issue which is causing distortions across the economy. What better time to signal higher rates than ahead of its October Eurobond roadshow to international investors?
CBN: Central Bank of Nigeria
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
SDR: Special Drawing Rights
VAT: Value Added Tax