Nigeria – Fixed Income Weekly

Starting today, I will start posting my personal views on developments in the Nigerian fixed income market at the start of every week. Hopefully this should get me blogging more frequently. Hope you enjoy this. Do leave comments on anything from writing style to your views on developments. The idea is to create a discussion around FI markets frequently.

Yours,

The week that was (June 28-30) – Are STABs becoming the new OMO?

  • Yield curve humps further: Last week, the NGN yield curve was a ‘tale of two curves’ as while Nigerian Treasury Bill (NTB) yields closed higher, FGN bond yields were largely static leading to further ‘humping’ of the yield curve. A hump occurs as interest rates at 3M-1yr tenors are elevated (19-22%) relative to longer dated tenors which currently range between 15.9-16.5%. At the short end, NTB yields climbed on average 45bps driven by a strong up-moves on the 91-day (+76bps) and 182-day (over 100bps) while the 364-day tenor declined 54bps. Lacking any policy impetus, FGNs were flat over the short trading week as portfolio managers closed their positions for the first half.
  • CBN ‘STABS’ banks yet again: On Friday the CBN pulled another shocker again with the mandatory debit of NGN285bn from banks accompanied by simultaneous issue of 6m 16% OMO securities. Though OMO auctions have now become a regular schedule, the increasing frequency of failed auctions alongside CBN’s desire to curb NGN liquidity means that STABs (Stabilization Securities) have become the new weapon of choice in biting system liquidity. Indeed comparing the two: net OMO bill issuance stands at NGN937bn over  H1 2017 vs NGN814bn for STABS in three auctions over Q2 17.
  • Personal statements of May 2017 MPC minutes sounding : In a departure from the usual late timing, CBN released personal statements of MPC members from the May 2017 meeting with the broad read-through indicating no major change in CBN body language. Consensus across members was on the repeated rhetoric of striking a balance between currency and growth with CBN preference towards the former informing their decision to stand pat at the May 2017 MPC.
  • Change of hands at the DMOLast week marked the end to an era in the Debt Management Office (DMO) with the retirement of the erstwhile DG Abraham Nwankwo who steered the DMO ship for over the last decade. Today it’s easy to forget that Nigeria’s debt market only became active 10years ago and Mr. Nwankwo played a hand in improving standards, disclosure and visibility in how the FG handles external and domestic debt.  Swiftly, the Presidency on nomination of the Ministry of Finance put forward a veteran of the DMO and ex-banker, Patience Oniha as the new DG.
  • No news on the Sukkuk something should come through the wires next week.

The week ahead (July 3-7) – Searching for clues

  • NTB auction: This week, the FGN would seek to rollover NGN177bn worth of NTBs across 91-day (NGN35bn), 182-day (NGN22bn) and 364-day (NGN120bn). As in recent weeks, CBN participation at the lower tenors should ensure this auction has a net neutral impact on markets. In addition, the FGN would conduct the savings bond auction for retail investors over the week.
  • Q3 17 Bond calendar release: DMO should release its Q3 17 calendar which could drive movement in FGN bond yields. Given sizable foreign borrowings in H1 2017 and softening appetite for domestic debt issuance, any signs of lower government borrowing from the calendar should fuel increased bond buying even as markets have to grapple with the redemption of NGN120bn of FGN 2017 in July-August.

Taking stock and setting sights ahead

With the first six months over perhaps time to take stock of FI yield movement since the start of 2017, the yield curve humped further as NTB yields rose over 400bp due to CBN tightening vs muted rise in bond yields (up 20bps). Accordingly, the S&P bond index is up 6.9% YTD (Q2 17: +2.7%). Over the rest of the year, likely softer government debt issuance and a mixed picture for inflation with bias towards upside stack up against continued hawkish monetary policy in defense of  the currency. This suggests further yield curve ‘humping though of a weaker scale relative to the last six months.

  • Increasing STAB issuance points to lower NTB yields:  In the event that CBN preference for STABS over OMO becomes established (which could be the case, as to the CBN, STABS are an improvement on OMO and more direct), then NTB yields could come under pressure as the amount of 16% paper in circulation gradually overtakes the 18-18.6% OMO paper in circulation.  Alongside CBN involvement in the primary auction, which has depressed 91-day and 182-day yields at the window, an increasing amount of paper with lower yields are going into circulation. Furthermore, the FGN is now in neutral mode in terms of net NTB issuance over Q3 17 as per calendar. Consequently, it is not out of place to conclude that NTB yields could succumb to 50-100bp moderation going forward.
  • Near term bullish, less so farther out for FGNs: For bonds, two things drive a bullish view on yields over the near term. As I stated earlier, the successful foreign borrowing spree in H1 2017 and better oil revenue picture means less pressure on the FG to borrow. Add the NGN120bn bond maturity in July-August and the current downtrend in bond yields should continue. Beyond these two terms, increased foreign investor activity in Nigerian equities over the last two months has resulted in valuations now looking stretched which raises the prospect of a temptation to seek out debt where prices remain below H2 2012-14 highs. Over the near terms, the confluence of factors (lower fiscal local debt borrowing pressure, maturities and likely FPI activity) point to some bullishness with yields moving to sub-16% levels over Q3 17.  Longer term, a higher interest rates at the middle segment of the yield curve is unsustainable as people start to discount other instruments with these.  Furthermore, once liquidity from maturing FGN bonds wash over (read Q3 end into Q4) and tamer base effects results in downward sticky inflation, I expect bond market bears to take over in the absence of monetary policy dovishness. In this case the bond segment  of the curve rises more relative to the NTBs.

In all, I believe my guess is we should see the ‘hard fork’ along the NGN yield harden over H2 2017 as lower fiscal influences drive FGN bonds lower while monetary impetus to curb NGN liquidity keeps NTB yields elevated – albeit less than before due the 16% STAB issues.

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