Nigeria Fixed Income Weekly

The week that was (October 1-18)

Bond markets appear focused on 2022, overlooking near term reduction in bond supply: In a reverse from the declining trend over Q3, when the yield curve dropped 106bps (H1 2021: +618bps), rates along the Naira curve have inched higher over October (+15bps) driven by a modest sell-off in bonds (+21bps). After a volatile end to September, markets appear to have turned bearish following the release of the proposed 2022 budget which incorporate another year of higher borrowings. This event has seen bond markets overlook the Q4 2021 bond issuance calendar where issuance appears likely to fall over the near term.

Figure 1: Naira Yield Curve

Source: FMDQ

DMO leaves market second guessing on T-bill trajectory: After hiking discount rates on the 1-yr NTB to 7.5% (Yield: 8.12%) at the prior NTB sale, the DMO lowered stop-rates to 7.25% (yield: 7.83%) following robust demand at last week’s auction and maintained its pattern of over-selling which takes net-NTB sales in 2021 to NGN859billion. The reduction appears to mirror the pattern in September when the DMO held stop-rates flat ahead of the monthly bond auction to manage yields and reverted to its hiking path subsequently. In my view, the DMO appears to be either bulking up via NTBs to cope with the larger-than-budget fiscal deficit (which is funded via more expensive Ways and Means) or planning to deploy those monies to fund its Jan 2022 bond redemption.

Base effects continue to drive inflation south, but underlying trends indicate pressures: The NBS reported that inflation slowed further in September (down to 16.63% y/y from 17.01% y/y in August) driven by moderation in food inflation which dropped below 20% for the first time in nine months to 19.6% y/y. Nigeria’s definition of core inflation (which excludes only food prices) tracked higher, up to 13.74% (August: 13.4%) while the real definition of core inflation moved to 14.4% from 13.9% in the prior month. Does this mean price pressures are coming off? Not quite. The deceleration owes much to the so called ‘base effect’ associated with the annualized reporting of Nigeria’s inflation numbers.

Figure 2: Inflation

Source: NBS

Given the dominance of food in most inflation baskets and the related seasonality from rain-fed agriculture, Nigeria and most African countries do not focus on monthly inflation trends. So September 2021 prices are compared against September 2020 prices vs the norm in developed countries where September 2021 prices are compared against August 2021 prices. However, this style has a chink, if prices rose strongly in the prior year, for headline inflation to rise in the current year, the pace of increase would need to exceed the prior year’s reading, or the headline print would fall. This is exactly what has played out in Nigeria’s numbers. In September 2020, monthly inflation rose 1.5% while it only rose 1.15% in September 2021. Though the September print is higher than August (1.02%), the higher base implied that for headline inflation to rise in 2021 the monthly reading had to be higher than 1.5% which was not so the drop in headline. This dynamic will stay around for the rest of the year so CPI will likely maintain a downtrend.

However, the underlying patterns are increasingly showing signs of non-food related price pressures possibly FX related and/or input cost inflation given the rally across most global commodity prices. These pressures is why we are seeing a pick-up in monthly non-food price trends though on the positive front farm produce prices dropped in September. This suggests that any progress on supply bottlenecks and food prices will likely start to slow. My suspicion as I noted in this article is we might need another crop cycle for things to really normalize.

Real wages and consumption spending rebound, but corporate profits, government spending and net exports yet to recover:  The NBS also put out GDP data disaggregated by income and expenditure approach and the read-through shows that employee compensation, which accounts for a around a third of GDP, and is a proxy for real wages rebounded (+19% y/y) while the trend in real corporate profits (which accounts for 66% of output) remained negative (down 4.5% y/y). On the expenditure leg, consumption and investment spending recovered while fiscal spending and net exports remained in contraction territory given the pressures on oil receipts.

Surprise Naira depreciation at the IE window, reserves maintain uptrend: The Naira dropped to a record low of NGN422/$ at the IE window well outside the NGN413-414/$ level in recent weeks. However, any concerns that this was the sign of a devaluation cooled as the exchange rate reversed to close at NGN415/$ levels. It would appear the CBN remains focused on a gradual Naira devaluation vs. a step-level change. Away from the official window, events appear to have flat-lined with currency quotes around NGN570-575/$.  Elsewhere, the 30-day average number of Nigeria’s external reserves continued to inch up (+8% MTD to USD39.2billion) post the USD4billion Eurobond sale.

The week ahead (October 20-23)

In the four-day trading week ahead, system liquidity is thin with OMO maturities of NGN85billion, some coupon inflows (NGN33billion) while markets will focus on the outcome of the monthly bond auction where the DMO has NGN150billion offer.

Over the rest of the year, bond markets appear to be underpricing the likelihood of a drop in bond supply implicit in the released Q4 2021. This likely reflects the view that these calendars, as the DMO has consistently demonstrated, are merely indicative given that its actual borrowing pattern over 2021 has deviated from the calendar targets. Tomorrow the DMO will look to make further progress on the remaining portion of its 2021 borrowing target, which by my estimates is down to NGN630billion. Given plans to sell NGN150-200billion worth of sukuk, alongside the target NGN400-470billion per the month looking at the calendar, the DMO can see clear line of sight to meeting its full year target. As the bonds on offer are premium bonds, this means face value sales could be even less. Add the option of maintaining net-NTB sales (which in my view gives the DMO flexibility to fund the January 2022 bond maturities) then the DMO could afford to play neutral with markets. From the September bond sales, the DMO appears unconcerned borrowing with the 30-year at 13% which suggests scope to undersell if average bids are priced in line with present secondary market levels on the paper but which leaves sizable room to take up more of the 15-year maturities which are sub-13%. Furthermore, bank demand for risk free paper (or any paper at all) remains solid, amid limited CRR debits and OMO sales, though a ramp-up in USD sales by the CBN could help drain banks bid for paper following the step-up in sales last week. That said in the light of heavy bank involvement in corporate issues such as MTN (possibly to grab more brownie points for LDR) one can safely assume that thier bid for risk-free instruments could remain strong over Q4 2021.

Beyond the near term, the 2022’s budget reveals another year of large gross bond sales (>NGN2trillion) which means markets will have to digest >NGN250billion a month. With the likely front-loading of pension fund MTM bond liquidations in January and prospects of increased paper supply, markets could continue overweighting those prospects over the near term reduction in supply afterall some holders have been looking for a chance to cash in on profits from Q3’s mild rally.

2 comments

  1. olafisayo ogunbiyi · · Reply

    Hi, Please can I have a phone number to reach you on?

    Regards

  2. Victor Ogundijo · · Reply

    Good day,
    Please what is your estimate of interest charge for the Ways & Means borrowing

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