The week that was (December 6-10)
Tight liquidity conditions continue to drive higher short-term rates: Liquidity conditions remained tight across the financial system as the CBN continued to look for means to curb Naira liquidity with another raft of out-of-cycle CRR debits on Friday. These debits have been growing in frequency since November and, amid soft coupon inflows, have worked to drain system liquidity. Unsurprisingly, bank activity in the CBN discount window has picked up in recent days and interbank rates closed the week higher at 17.5-17.75, a development which has mirrored a pick-up in placement rates to 12-13%.
DMO reverts to a ‘neutral’ posture at the T-Bill auction: At the fortnightly NTB auction where there was NGN54billion worth of NTB paper on offer, debt markets were positioned for two things: that yields would fall further and that the DMO would maintain the pattern of issuing more than its offer. Despite the deeply negative real yields on offer at the auction, demand remained robust with bid-to-cover ratios of 4.6x (previous 3.5x) which allowed the DMO issue debt at lower yields with the 1-yr stop rate falling to 5.34 (yield: 5.6%) from 5.89 (yield: 6.3%) at the last auction. This marks a return to the pattern before 2021 when the DMO would issue essentially the amount of T-bills maturing leaving a net-neutral impact on market liquidity. Since June, the DMO has sold more paper than on offer (i.e. net issued debt) to the tune of NGN1.04trillion by my estimates and reversal to a neutral position would suggest that the DMO is now within sight of its 2021 borrowing plan as the year comes to an end. More on this later.
That said, worth highlighting is the disorganization in the T-bill market which is now three-way. The NTB instruments are trading at 5.6% yield for the 1yr, while the SPEB securities issued by the CBN (with tenors now extended to 180-days) are much higher with the 6-month bill at 6.1%. Lastly, you have the OMO bills by the CBN at 10% for the 1-year tenor. The three-tier fracturing of short-term risk-free instruments is testament to the CBN’s heterodox approach and suggests dissonant thinking by Nigeria’s economic managers.
A roller-coaster week for bond markets, Lagos successfully returns: As with the underlying trend in recent weeks, bonds continued to emit bearish sentiments with a lot of offers across the intermediate and long segments of the curve while the front-end continued to see buying activity from banks. However, following the NTB auction where the DMO switched to a neutral posture, markets interpreted the action to mean the DMO is likely going to cut back on bond sales at next week’s auction given the existence of a planned sukuk sale. This prompted fresh buying action at the long end with the 2050s retreating some 20bps over the week. The 2045s also saw strong buying which reflects renewed attempt at short-covering as the year draws to an end given DMO’s cessation of issuance on the tenor. In the non-sovereign space, Lagos State closed out on its NGN125billion bond issuance program during the week after clearing some last-minute regulatory hurdles with an oversubscribed sale at 13% for a ten-year bond.
Figure 1: Naira Yield Curve
FX reserves maintain downtrend, USD liquidity remains challenged: Nigeria’s external reserves declined 0.4% w/w to USD40.9billion reflecting the step-up in CBN interventions across FX markets. However, the naira fell at the IE window (-0.1% w/w to NGN415.10/$) and parallel market (-1.2% to NGN574/$). In terms of activity, total turnover rose 32% w/w to USD1.2billion dominated by spot contracts (86% of total transactions). The two-tiering of the market continues to reflect limited USD supply in the IE window amid the CBN’s hard peg on pricing within the segment even though the apex bank is selling to offshore investors at weaker levels of NGN440-460/$.
The Week Ahead (December 13-17)
In the week ahead, system inflows entirely comprise the OMO maturity of NGN40billion and given the bond sale suggests liquidity pressures are likely to remain over the course of the week.
December 2021 bond auction: At the last bond sale in 2021, the DMO has NGN100billion on offer across the 2026 and 2037 bond. YTD, the DMO has sold NGN2.6trillion which relative to the NGN561billion in bond maturities implies net bond sales of NGN2.1trillion. However, with net NTB sales running at over NGN1.1trillion and a planned sukuk sale of NGN200-250billion, the headroom for an aggressive bond sale at this auction is small. In the light of the DMO’s neutral posture at last week’s NTB sale, one could argue that the DMO is likely to undersell at this auction. In the secondary market, the two auction papers closed at 11.28% and 12.86% respectively though secondary market trading levels are around 12.3% (2026s) and 13.03% (2037s) respectively.
Farther out, despite looming FGN bond maturities in January (NGN605billion) which should inform bullish expectations, debt markets remain bearish as demand for bonds remains soft. Pension funds have cut back on T-bill holdings given depressed negative real yields and the sector has large MTM bond positions (> NGN300billion) which will likely be offloaded in the new year as unrealized losses from 2021 drop off. The prospect of these sellers overwhelming debt markets in early January could work to put off any demand for now. In addition, the 2022 budget points to another year of record borrowings amid an enlarged NTB issuance program following the record sales in 2021. The balance between demand and supply of fixed income securities which was upended by CBN’s proscription of non-bank investors in 2019 will likely swing back towards supply after two years. Beyond Q1, system inflows are going to pale in comparison to what the DMO needs to borrow to fund the large fiscal gap over 2022. Throw in sentimental positioning ahead of the 2023 electoral cycle and we are in for interesting times ahead. The big unknown is how the CBN responds and thus far they have remained accommodative which caps scope for any sustained increases in the yield curve. However, how long before that position changes in the face of FX reserve declines?
CBN – Central Bank of Nigeria
CRR – Cash Reserve Ratio
DMO – Debt Management Office
IE – Investors & Exporters
NTB – Nigerian Treasury Bills
OMO – Open Market Operation
SPEB – Special Bills
YTD – Year to Date