Nigeria – Fixed Income Weekly #2

The week that was (July 24-28) – Yield curve rises as CBN signals ‘no retreat, no surrender’ on tightening

  • Benchmark NTB yields inch higher as CBN remains committed to tightening: Despite a liquidity deluge from OMO & FGN bond maturities and FAAC inflows, which drove OBB and O/N rates into single digits at the end of the week, key Nigerian Treasury Bill (NTB) yields trended higher on average over the week: 91-day ( up 400bps), 182-day (flat 100bps) and 364-day (up 60bps) to 18.84%, 19.67% and 22.89% respectively . Though the 91-day reflects a re-pricing, the new level is some 80-90bps lower and possibly reflects heavy liquidity at the short end which drove O/N rates lower.  Keeping to form, the CBN issued NGN318bn worth of OMO bills to more than take out NGN65bn in maturities even as the MPC sounded largely hawkish at the end of its two day policy meeting last week.
  • MPC remains firmly hawkish:  In line with market expectations, the CBN by a 6-2 vote retained all policy parameters at the end of its two day monetary policy meeting. While 2-members voting to cut hints at easing, my suspicion is that these were independents not CBN members as the governor’s address sounded largely hawkish. Importantly, the CBN introduced a new variable (threshold inflation) into its forward guidance. This suggests inflation below this level, which the CBN states is 12%, would cascade into monetary easing. Under this scenario, it would mean no rate cuts in the horizon given my 2017 year-end inflation forecast range of 14.9-15.3% y/y.
  • Bonds continue uphill climb: Bond yields continued their northern ascent driven by continued sell-offs across the 7-year (where yields climbed 10bps) and  20-year(up 11bps). Some segments of the far end of the curve did not trade two-way due to issues with the CBN bond settlement system.  That said the broadly rising trend in yields, as I noted last week, reflects thinning liquidity available to PFAs after deploying the April 2017 FGN bond maturities and rising opportunity costs from two fronts: a) higher NTB yields and b) a strong run in equities (up 37% YTD) given enlarged statutory allocations. Under this scenario, the returns to holding bonds given CBN hawkishness does not appear to be enough compensation and hence the sell-off.

In summary, CBN signaling of a retention of its tight stance is keeping NTB yields elevated. Farther out, as NGN equities have assumed fresh momentum, the hurdle rate for bonds is now much higher than in the past which is driven bearish action at the longer end of the yield curve.

The week ahead (July 31 – August 4) – Tread cautiously as market trades ‘indicatively’ but bond market bears to gain ascendancy

  • In the week ahead, the FGN would seek to rollover NGN229bn at the NTB auction on Wednesday and there is an NGN85bn OMO maturity on Tuesday. In terms of events, markets are likely to trade cautiously as issues with the CBN settlement system which has generated a back-log of unsettled trades prevents 2-way trading of debt instruments.
  • Hawkish MPC forward guidance and roaring equities to keep debt market bears in charge: The key takeaway from the July MPC is that the CBN remains committed to contractionary monetary policy which implies continued deployment of various measures to sap system liquidity. Importantly, markets now have a realistic short term inflation target of 12%, which should continue to underpin sell-offs along the yield curve. Complicating the picture for bond market bulls is that NGN equities show no signs of halting their ascent to 2-year highs which is drawing away liquidity from fixed income to equities. In the last two years, bonds have enjoyed a steady flow of funds away from equities. Now I suspect given an enlarged regulatory leg-room to take on equities risk for PFAs, amid a fundamental re-rating in equities, bonds are likely going to take a pounding.

Going forward, NTB yields are likely to remain stuck in the 19-23% range while bond yields are likely going to test new highs. I leave with a chart below on average marginal rates on FGN auctions and bid-cover rates.

Figure 1: Average marginal rate at monthly bond auctions and bid-cover ratios

Average marginal rates v Bid-cover ratio

Source: DMO, CBN, FMDQ * Jan-July


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