Nigeria – Fixed Income Weekly

The Weeks that were (June 27 to July 15, 2022)

NTB yield curve inversion, CBN starts to tighten, inflation tracks higher, Naira devalued at the official windows and external accounts turn positive.

Fixed income markets turn bearish as CBN tightens the screw on liquidity:  After a largely lukewarm attitude towards financial system liquidity over the first half of 2022, the CBN appears to have moved to a less tolerant posture beginning in late June and well into July. This can be seen by looking at aggregate banking sector activity within the CBN discount window where the daily net borrowing position by banks has averaged NGN98billion thus far in July. This is an uplift from average net daily borrowing positions of NGN79billion in June and NGN27billion in May and a net depositor position over most of Q1 2022. This pick-up reflects the return of adhoc CRR debits as well as the stoppage of the weekly refund of excess CRR debits in late June. Alongside a pick-up in USD interventions over June which come with restrictions around access to CBN discount windows, the buildup in liquidity pressures resulted into forced liquidations of NT-bill positions and the NTB curve promptly inverted with 1-3month NTB/SPEB securities selling for 9-11% as against 6-7% on the 1year tenor. This cascaded through the curve with increased selling along the front-end (~100bps) relative to the belly (+40bps) and long end (+20bps).

Figure 1: Naira Yield Curve

Source: Bloomberg

DMO lets slip a secret at the NTB auction as CBN net issues OMO in June: Amid the sell-off along the front end, the DMO let slip on one of its cards at the primary market auction for NTB. As usual, the CBN, on behalf of the DMO offered NGN143billion and sold precisely what was offered at respective stop rates of 2.75% (previously 2.40%), 4.00% (previously 3.79%), and 7.00% (previously 6.07%). This precise allotment (i.e., the DMO essentially rolling over debt that was maturing) seemed normal until sandwiched between the results was a strange line called ‘CBN bridge finance’ which as would be clear implied that the CBN essentially provided the balance plug-in figure for the DMO to complete the rollover at the clearing rate of 7% for the 1-year. Though the CBN would later recall and re-issue the results without the line, the secret was out and markets are now well aware that the CBN is an active participant in NTB auctions with a get-out-of-jail-card for the DMO in the event of undersubscription. This provides further evidence that Nigeria’s economic managers look to cap any upside in yields through. In between the last month of June, the CBN data shows the apex bank net issued OMO bills over the month which as we shall see later is consistent with gradual ramp-up in liquidity tightening measures over June.   

Inflation tracks higher in June 2022 on higher diesel and food prices: Inflation surged to a 65-month high in June with consumer prices jumping by 18.6% y/y (May: 17.7% y/y) according to data released on Friday by the National Bureau of Statistics (NBS). This sits roughly within my expectation (18.64% y/y) and continues to be largely driven by pressures in food prices (20.6% y/y) in particular domestic farm produce where prices rose north of 21% relative to 2021 levels. The pressures were more pronounced in urban farm produce prices which provides evidence that elevated diesel costs (+200% y/y) continue to adversely impact transport costs for food. Elsewhere, Nigeria’s ‘definition of core inflation’ continued to move through the gears rising to 15.75% in June (True Cored definition: 15.7% y/y) which would suggest that inflationary expectations are becoming entrenched on account of currency weakness

Central to the current inflationary spiral is the fall-out from the Russia-Ukraine conflict and its impact on energy prices (which have climbed north of 70% this year) as well as the second order impact on the prices of critical food commodities like wheat, fertilizer, grains etc. In addition, the resurgence in true core inflation (which excludes the food and fuel price elements) provides some evidence to the argument that Naira weakness and USD shortages, a by-product of CBN’s unorthodox interest rate policy which curbed much needed portfolio flows are driving a repricing of producer prices across the economy. This posture which provided liquidity cover to fund excessive fiscal deficits played a big part in the strong expansion in money supply over the last three years which have contributed in no small measure to current price pressures.

Figure 2: Inflation

Source: NBS

Over the rest of the year, headline inflation appears set on a pre-set course to clear 20% by September 2022 given adverse some favourable base effects and assuming no further increases in diesel prices should likely peak in November at 22%. Over the year, inflation is likely to average 18.9-19% (2021: 17%).

Figure 3: 2022 Headline Inflation Forecasts

Source: Authors Calculations

Money supply data signposts a shift in CBN posture towards tightening in June:  Money supply data over June showed a deceleration in the pace of monetary expansion as annualized growth across the main broad money aggregates M3 and M2 came in at 23% and 22.7% respectively, down from 26.1% in May. This is the first such slowdown in 2022 and comes as the CBN stepped up on securities issuance (+NGN69billion) and ramped up on Cash Reserve Ratio (CRR) debits (+NGN117billion to NGN11.3trillion). This is consistent with tightening liquidity conditions towards the end of June which has continued thus far in July 2022. From a structural perspective, money supply growth remains driven by a credit growth across the private sector (+23.2% annualised to NGN39.3trilliom) and government (+70.1% annualized to NGN16.9trillion) while net foreign assets (in Naira terms) have large contracted in tandem with the drop in Nigeria’s external reserves thus far in 2022. 

Figure 4: Money Supply Data

Source: CBN

Nigeria’s external account returns to positive territory thanks to higher oil prices:  CBN data shows that Nigeria reported a current account surplus of USD2.6billion (3.5% of GDP) vs a USD4.7billion deficit in the same period in 2021. This stemmed primarily from stronger oil exports (+166% to USD13.5billion) thanks to higher oil prices (+70%) and production was largely weaker (-10% to 1.56mbpd). Non-oil exports (+85% to USD1.9billion). Import growth appeared restrained with goods imports only up 7% due to lower service imports (down 7% to USD3.8billion) while goods imports were up only 12% to USD13.7billion. The measured import demand growth likely reflects the import suppression by the CBN due to limited USD supply over the period.

Figure 5: Current Account Surplus

Source: CBN

CBN stealth weakens the Naira again, multiple exchange rate returns: Despite rising USD reserves which climbed over the last one month to USD39.4billion, the CBN gradually weakened the Naira at the official IE window with the exchange rate now trading at NGN430.3/$. This is a turnaround from the dramatic revaluation in Q1 when the Naira ‘appreciated’ to NGN415/$ after closing the 2021 at NGN435/$. Away from the supposedly flexible official window managed by its associate FMDQ, the CBN has created other windows for its intervention: one at NGN420/$ (for end users for PTA/BTA, health bills and school fees), another at NGN440-455/$ for foreign portfolio investors and a third for weekly spot and forward sales to corporates anywhere between 430-450/$. In between all of this, there is another rate used in FAAC calculations provided by the CBN to NNPC which stood at NGN392.35/$ in June. This complex web of different rates will be a legacy of the Emefiele era at the helm of the CBN as is the widening premium of the parallel market rate with the official with the latter now at NGN620/$.  

The Week Ahead (July 18-22, 2022)

The week ahead is loaded with activity as there will be on bond auction on Monday and the CBN will close out on its two-day monetary policy retreat on Tuesday. On the liquidity front, there are some coupons but also large bank liquidity debits for settlements for the bond auction on Wednesday and Dangote Industries bond (NGN185billion).

Rates likely to track higher at the July 2022 Bond Auction:  At the July bond auction the DMO will look to sell NGN225billion worth of bonds across the 2025, 2032 and 2042 papers. As of Friday, the three papers were trading at 10.2-10.3%, and 12.65-12.78% and 13.1-13.3% respectively. Bond markets have become bearish lately and the uptick in short term bank placement rates (12.5-14%) given the tight liquidity conditions amid prospects of higher inflation and larger government borrowings will likely curb the appetite for bonds at current levels. As with recent auctions, the DMO is unlikely to want to yield much ground on clearing rates and given the CBN option at the NTB segment can afford to play hard ball. Under this setting my guess is that we see some concession on the shorter tenors with the 2025s likely closing at 10.5-11% while the 2032 and 2042 will likely move higher to 12.75-13% and 13.2-13.3% respectively.

CBN likely to deliver further rate hikes: Following the 150bps points hike in the monetary policy rate (MPR) in May, the norm looking at CBN history is to adopt a wait-and-see approach in the meeting after an MPR adjustment. However, the continued surge in inflation amid continuing problems with the FX environment will likely tempt the CBN towards entertaining fresh hikes. Interestingly, the CBN Governor, after staying out of the media limelight following his failed presidential campaign, was in the news over the weekend with mention about an evaluation of monetary policy over the last three years. Essentially the CBN governor is embarking on a review of his unorthodox monetary policy approach which commenced in 2019 and my reading of these comments alongside CBN’s liquidity tightening actions across money markets suggests the July 2022 MPC is likely to herald a return to normalization. To undertake this in a credible manner, the CBN would need to undertake an additional 100-200bps increase in the MPR, return to a symmetric corridor of 200-300bps around the MPR and remove the bifurcation in fixed income markets with separate interest rates for OMO and NTB sales. Are they ready to fully normalise? My hunch is we should see some signs at this MPC meeting with additional 100bps increase and some tweaks to the corridor.

Figure 6 : Monetary Policy and Bond Yields

Source: CBN  

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