Nigeria Fixed Income Weekly

The week that was (September 17- 30)

Nigeria tapped global debt markets for USD4billion. The DMO maintained the pace of its borrowings and now looks set to reduce the gap between OMO bills and NTB papers.

NTB Auction: A desire to trim spreads? After its surprise hike in the discount rate of the 1-yr NTB from 6.8% to 7.2% in early September, the DMO’s subsequent pause at the mid-month NTB sale (where it held rates flat at 7.2%) left debt markets confused about its real intentions. However, at the last NTB sale in the month, the DMO delivered a 30bps increase to 7.5% and the manner it was done suggests that, as with the first increase, this move was deliberate.  At the auction where there was NGN112billion to be re-financed, the DMO oversold the offer by a mere NGN2billion on the 1-yr tenor. Essentially, the DMO could have worked away without the NGN2billion and still closed lower by deploying its non-competitive bids which it likely deployed at the mid-month NTB sale that closed at 7.2%.

Furthermore, given the unusually late publication of the auction results, it seems clear that the decision to move it higher was certainly not a mistake. Why is the DMO nudging NTB yields higher? My sense is there is probably a growing need to reduce the spread between the 1yr NTB paper (7.5%) and OMO bill (10%) to reduce the incentive to arbitrage both windows.

Divergent trends across bond markets:  In response to the NTB outcome, fixed income markets have been mixed with bearish trends at the long end and strong buying activity along the front-end. The front-end buying activity is being driven by banks and possibly offshore investors likely looking for a better yielding outlet to park idle cash balances (in a bid to escape CRR debits from the CBN). On the long end, sell-offs reflect non-bank investors wary about the implications of 10-11% effective yields on a 1-yr NTB on bond yields and the unwinding of the dubious ‘Eurobond displacement of local borrowings’ trade that had swung markets bullish over the last two months. As is now clear with the outcome of the September 2021 bond auction, a Eurobond sale has zero bearing on domestic borrowing patterns as both are separate.

Figure 1: Naira Yield Curve

Source: FMDQ

DMO maintains over-selling pattern at the September 2021 bond auction:  As I had noted in a prior post, the idea that a Eurobond sale would somehow shrink DMO’s appetite for local bond issuance lacked any serious merit. It was essentially a ‘buy the rumour, sell the story trade. In financing the record NGN5.2trillion shortfall, the National Assembly had evenly split the shares for domestic and foreign i.e. both legs are separate and neither is a substitute for the other or can be without a formal request for a switch. As such at the monthly bond auction, the DMO had no qualms lapping up the available bids for its NGN150billion offer with a total of NGN277billion bonds sold. Hot on the heels of the USD4billion Eurobond sale, the relatively large tap of the domestic bond market (relative to market expectations for an under sale) wiped any illusions that Eurobonds would reduce the need for domestic borrowings and accordingly sentiment across long-end bonds have turned bearish.

In hindsight the decision to freeze increases on the stop-rate at the 1-yr NTB sale in mid-September likely reflected a desire to manage bond markets ahead of the auction as secondary market yields were rapidly approaching 14% in response to the initial hike.

Nigeria’s Eurobond sale: Nigeria returned to global debt markets after a three-year hiatus with a USD4billion sale, upsized from an initial USD3billion offer, following strong demand with an order book size of USD12.2billion. The weighted average coupon comes in at 7.3%, much lower than the double-digit obtained on Naira borrowings, but the sale raises Nigeria’s weighted average cost on external debt to 6% (2020: 5.1%) by my estimates. Nigeria’s external borrowings rise to USD37.5billion (9.6% of GDP) of which Eurobonds comprise USD14.7billion. In terms of debt mix, Nigeria’s external debt remains largely concessionary though the commercial debt component has trebled from 2015.

Figure 2: Nigeria External Debt Mix

Source: DMO, Authors computation

Nigeria’s external accounts improved in Q2 2021 thanks to rising oil prices, FX reserves track higher:  CBN data shows that Nigeria’s current account deficit narrowed in Q2 2021 to USD420million vs USD2.1billion deficit in Q1 2021 and USD3.3billion shortfall in Q2 2020. The improvement largely reflects a strong rebound in crude oil exports to USD11.2billion (+76% q/q, +117% y/y) thanks to higher crude oil prices. FX reserves moved higher (+4.5% to USD36.4billion, 4.9months of import cover) reflecting the SDR injection and should now move towards USD40billion (5.4months of import cover) by the end of October with the Eurobond sale.  

Figure 3: Current Account Deficit (USD’bn)

Source: CBN

Money supply data shows that CBN remained accommodative over August: CBN’s money supply data for August showed further expansion in main monetary aggregates (M3: +5%, M2: +12%) reflecting faster growth in quasi money (+18%) which continued to fund credit growth (+16% annualized). On the liquidity management front, CBN resumed its OMO bill issuance during the month which drove an uptick in CBN bills (+NGN115billion over the month) which outweighed growth in CRR debits (+NGN69billion). Overall, one gets the sense that having tightened liquidity in Q2 2021, the CBN moved to an accommodative posture in Q3 2021 where it tolerated excess Naira liquidity which worked to push interest rates lower.

Q4 2021 bond issuance Calendar shows lower borrowings: The Q4 2021 bond calendar shows a drop in monthly bond sales from an average of NGN243billion to NGN150-180billion in October-November and a led-down to NGN100-120billion in December. In terms of maturities, the DMO exited the 2027s and 2036s, now replaced with 2026s and 2037s which are both premium bonds implying a higher cash value while the 2050s are likely to take a pause after November. Predictably these replacements should drive short-covering rallies.

The week ahead (October 4-8)

In the week ahead, system liquidity is thin with no scheduled NTB or OMO maturities and no FGN bond coupon payments. That said, NGN500billion of CBN special bills (SPEBs) should mature and will likely be rolled over leaving market liquidity largely neutral.  

Q4 2021 Outlook: In framing my views over the rest of 2021, one needs to take stock of where we are on supply and demand. On the supply side, the DMO calendar makes it clear that FGN paper supply is unlikely going to be an issue for bond markets to worry about in Q4 2021. That said, system maturities are thin beyond October and non-sovereign issuance looks heavy with a planned NGN125billion bond sale by Lagos and MTN Nigeria’s NGN90billion bond sale among others likely to present outlets for non-bank liquidity to find a place. However, having stayed neutral to Naira liquidity over last three months, ongoing FX illiquidity troubles and how the CBN deals with the issue present the key unknown. While macroeconomic and some technical factors (SDR + Eurobond sales) suggests greater ability by the CBN to improve USD supply across FX markets, one struggles to see how this does contain some form of liquidity tightening at some point accompanied by further Naira devaluation. But the CBN could chose to remain unorthodox, as we have seen since 2019, the Governor certainly has stiff appetite for the unconventional which could mean finding unusual ways to keep rates depressed and prolonging the current FX impasse. In all, markets are likely to trade sideways with activity around NTB and bond auctions. Farther out, Nigeria’s medium term expenditure framework from which annual budgets are drawn from points to a large fiscal deficit in 2022 which points to large bond issuance program next year. With early maturities and rising political risk premiums over H2 2022 as the 2023 elections draw into focus, interest rates are likely to move higher over the medium term.

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