Robust liquidity levels and dovish CBN posture underpins a modest rally in Nigerian Fixed Income, Naira woes continued
Robust financial system liquidity keeps money market rates depressed: Following the repayment of around NGN605billion of the FGN 2022 bond in late January, rates across Nigeria’s money markets have buckled under the weight of the resulting liquidity deluge. The large liquidity inflows from bond repayments were complemented by CBN switching to a net redemption position on its OMO bills in Q1 to the tune of NGN677billion. Consistent with this tolerant posture towards liquidity, the CBN adopted a less aggressive posture to CRR debits which ensured that banks generally had enough cash buffers during the period. This was evident looking at discount window information which showed that Nigerian banks switched from net borrowing from the CBN’s discount window to become net depositors in the segment. Interbank rates averaged in the low single digits for much of the period while placement for large institutions hovered between 5-7% down from 11-12% in early January.
DMO takes advantage of robust liquidity to borrow aggressively, but still a long way from home: Over the first quarter, the DMO sold NGN883billion worth of bonds and NGN1.3trillion worth of NTBs. Adjusted for maturities, the DMO sales imply around NGN278billion of bonds and NGN461billion worth of NTBs. Ordinarily this would suggest securities supply exceeded investor demand so why did yields maintain a downward trajectory? The answer lies in the CBN’s action on its OMO bill maturities where the issued only NGN570billion in bills relative to NGN1.2trillion in maturities implying a net injection of liquidity into the financial system. These OMO releases provided an extra layer of liquidity into the banking system at a time the CBN was cool on CRR debits. In terms of target, the DMO’s initial domestic borrowing target was for NGN2.5trillion in new borrowings. Following the decision to retain fuel subsidies, President Muhammadu Buhari has sent an additional request for domestic borrowings of nearly NGN1trillion which sets the DMO local borrowing target at a record ~NGN3.5trillion. Anyway, you cut it the DMO still has a long way to go in terms of 2022 borrowings.
Yields curve steepening over Q1 2022 as banks bid up front-end papers: Against the backdrop of robust system liquidity occasioned by dovish monetary policy, interest rates along the Naira yield curve declined over Q1 2022 (down some 100bps). Though the leg-down appears roughly even, with average compression of 98bps along NTBs and 101bps for FGN bonds, the reality was more nuanced as the front-end witnessed declines of 140-240bps focused on the 2-3year tenors as banks aggressively bought short-dated bonds as a coping mechanism for dealing with the trifecta of low NTB yields, adhoc CRR debits and the need for some tax shields given the changes in the Finance Act which had removed the tax-free status on income from NTB instruments but retained it on FGN bonds. Essentially, this meant banks had a natural reason to desire holding bonds of short duration.
Figure 1: : Naira Yield Curve
Inflation tracks higher on rising energy costs and higher food prices, more pain to come: On Good Friday, the National Bureau of Statistics (NBS) released the March 2022 CPI report which showed that inflation accelerated to 15.92% y/y (prev: 15.7% y/y) with the monthly print coming at 1.74% (prev: 1.63%). The uptick is consistent with higher energy costs over March when Nigeria experienced a bout of petrol/diesel shortages, a surge in diesel prices (YTD: +157% to NGN650/litre) and a collapse of the power grid. The petroleum product pressures filtered through to transport costs which have accelerated all through Q1 2022. Over the rest of 2022, the outlook trajectory appears upward as a combination of price pressures from non-deregulated fuels (diesel, kerosene etc), higher transport costs and still subdued food production generates sufficient runway for inflation to raise towards the 16-18% territory.
Figure 2: Inflation 2022 forecasts
Source: NBS, Authors Calculation
Money supply data shows relaxed CBN position on system liquidity: Latest CBN data on money supply trends as of February 2022 show that the apex bank remained broadly tolerant of elevated system liquidity. Broad money (defined in Nigeria as M3) rose at an annualized rate of 12.7% or an increase of nearly NGN1trillion in absolute terms and was largely driven by an expansion in demand deposits following the inflows of cash from the FGN 2022 Bond repayment as well as OMO maturities. Net Foreign Assets (NFA) fell over the period, in tandem with the observed decline in Nigeria’s external reserves (more on this later), though this was offset by strong expansion in net domestic assets (annualized: +35%). Credit growth remained strong across the private sector (+29% annualized to NGN36.9trillion) and government (+72% annualized to NGN14.9trillion. Aggregate CRR debits stood at NGN10.4trillion at the end of February (2021 year end of NGN9.7trillion).
CBN returns to ostrich FX policies of 2016-17: After plunging to NGN435/$ at the end of 2021, the Naira promptly appreciated at the start of 2022 to NGN416-417/$ within the IE window. This pattern appears to be a reprisal of the sequence last year when the Naira was allowed to fall in the tail end of 2020 before a subsequent rebound. This teleguided pattern pours water on the idea that IE window is a market even though the CBN continues to claim otherwise. Seems clear to everyone that the exchange rate in the IE window is now being dictated by the occupants of Plot 33 Abubakar Tafawa Balewa Way Abuja. The CBN’s actions mark a stunning return to the 2016-17 era where the naira traded at different rates: NGN199/$ in the official windows and much weaker (NGN500/$) at the parallel market. Only this time the rates are different: NGN416/$ at the IE market which is the new official and NGN580-595/$ at the parallel market. Strangely one wonders why FMDQ persists with this chicanery given the strong advocacy role the Exchange played in creating this market and ending the previous charade!
USD liquidity profile deteriorates; banks reduce monthly limits on Naira cards: After falling by over 2.4% in Q1 2022, Nigeria’s external reserves are up in April (0.4% to USD39.7billion). The improvement likely reflects inflows from the USD1.25billion Eurobond sale in March as against the impact of higher oil prices given the issues with oil production and the subsidy payments. Over the period, USD liquidity has thinned across FX markets with average turnover of USD122million in the IE window, down from USD188million in Q4 2021. The deterioration in USD liquidity has resulted in a reduction in monthly USD limits on Naira cards across most Nigerian banks to USD0-20 from USD100-150/month previously.
Figure 3: FX reserves and Import Cover
Source: CBN, Authors Calculation *March 2022
The Week Ahead (April 19-22)
Given the Easter holidays, we have a short four-day trading week which precedes the bond auction next week. Market positioning is likely to remain soft. In terms of liquidity, there are OMO maturities of NGN23.9billion which is quite thin. Markets are likely to be dominated by sideways trading in the week ahead of the monthly bond auction.
CBN to switch to liquidity tightening over May-July, curve steepening in the interim: The release in early April of the Q2 2022 bond calendar which showed a pick-up in borrowings from the NGN150billion mid-point in Q1 to NGN225billion over the next three months sparked a sell-off in bond markets. The long end backed up towards 13% while the front-end and belly of the curve have slowly but gradually inched higher. This likely reflects heightened selling by non-bank investors with an eye on increased supply in the coming months. However, with short-term interest rates anchored at 5-6% and 1-yr NT-bill yields at 4.6%, its looks tough for bearish sentiments to persist and markets now appear stuck in this going-nowhere zone. However, from a fundamental perspective, system liquidity from the OMO and FGN bond maturities are now largely dissipated which implies that any fresh supply influence be it the FGN or corporates will place downward pressure on bank liquidity positions. For the less liquid Tier II banks and merchant banks this will likely result in upward pricing of placement rates over Q2 which would seem to account for the sudden rush by these banks to sell commercial papers of late.
However, for the yield curve to move higher, the CBN would need to come around to the view that it needs to rein in excess liquidity and signal higher interest rates. On this wise, the outcome of the last MPC meeting which ended in a 6-4 vote with the dissenters (likely independents) calling for rate hikes makes the next two meetings something to watch. Inflation readings are likely to get worse with April 2022’s print likely headed towards 16% which the MPC will have to digest at the May 2022 MPC, and the FX pressures are likely to have gotten worse at the parallel market. I now expect the CBN to start getting out of its 3-year foray into unorthodox monetary policy by May with a progression to full-on tightening by July 2022 if not earlier. In terms of specifics, we could see MPR hikes in the 150-200bps region alongside tweaks to the discount window facilities to be complemented by more aggressive CRR debits. If this happens, a parallel upshift in yield curve is on the cards. Pending that policy adjustment, front-end yields will remain contained by bids from banks while non-bank investors continue to net offer their holdings of instruments along the belly and long-end of the curve.
No respite for the Naira until the CBN returns to orthodoxy: Following the Eurobond sale in September 2021 and IMF SDR injections of August 2021 which boosted external reserves, the thinking among most analysts was that the CBN would use the fresh USD ammunition to improve supply across FX markets. Given that inflation remained above target even as the economy had completely exited recession, the sense was that if there ever was a time to start normalizing monetary policy, the stars had aligned over Q4 2021. However, the CBN simply ignored the tea leaves and maintained course taking comfort in the sluggish inflationary trends and doubled down on its unorthodoxy. This harks back to July 2015 when the CBN faced similar scenario and moved to impose a hard peg on the Naira and slashed USD supply to all segments (especially the BDC operators) which eviscerated any form of trading and resulted in a two-tier market as currently obtains. In the event that the CBN chooses to maintain the status quo and hold-off on any rate hikes, we are likely to see the Naira heading over NGN600/$ at the unofficial market, while the IE rate reported by FMDQ remains anchored at the pegged NGN415/$ level.