The week that was (Sept 11-15) – Build-up in system liquidity induces strong buying across the yield curve
- Yield curve succumbs to mounting liquidity: Last week, the Naira yield curve declined across board as the CBN stood askance for the second consecutive week, allowing a build-up in system liquidity to trigger strong buying activity. For the second week in a row, the 1-yr tenor declined by 100bps on Friday as the market responded to the delayed results of the NTB auction on Wednesday (which came out just before close on Thursday). The lead-up to the auction was marked by uncertainty over the exact offer size as the CBN left it till late before releasing the calendar which showed a rollover of the Thursday maturity. The NTB calendar itself showed that the FG would remain net neutral in terms of issuance and would seek to rollover the NGN917bn maturities in Q4 17.
- At the auction, CBN took advantage of significant demand at the 1year (with bid-cover of 3.9x) to issue the tenor at an effective yield 115bps lower than at the last debt sale of 21.6% (discount rate: 17.75%). Already rising system liquidity, as the CBN sold only 33% of planned offers, which resulted in a net repayment of NGN86bn OMO bills, set the stage for a collapse in secondary market rates ahead of the auction. However, the 6-month tenor rose over the week, as the market interpreted the marginal rate on the 6M OMO offering of 17.95% (effective yield of 19.67%) as the comfort level of the CBN. OBB/Overnight rates dropped to 11/12% from the 20/22% levels at the start of the week.
- In a similar vein, FGN Bond yields reclined (down 20bps on average) with strong buying on Friday as limited supply of 1yr bills (following CBN’s switch last week to lower OMO tenors) induced a push by pension funds to increase purchases across the deep end of the curve.
- ..Inflation continues the slow grind south: Last week, the National Bureau of Statistics (NBS) released August 2017 inflation numbers which showed that inflation sank for the 7th consecutive month to 16.01% y/y. Importantly, as I noted in the prior week, was the drop in m/m inflation below 1% to 0.97% as lower energy costs and early harvest underpinned a moderation in farm produce inflation. Core inflation remained stuck at the 12% territory while food CPI remains elevated looking at the annualized reading at 20.25% but slowed for the third straight month to 1.1% m/m from a peak of 2.5% m/m in May.
- Sukkuk bond sale commences: After a long quiet hiatus, the DMO got back on track with the Sukkuk bond by releasing further details of the offer. The issue would be a 7-year NGN100bn issue with a rental rate of 16.47% — in line with the market rate on Thursday and would close on September 20. The issue would be used for road projects though left unsaid is how the FGN hopes to repay rental proceeds on the project in line with the requirements of Islamic Finance with no announcements on tolling.
- In summary, amid declining inflation, CBN’s reluctance at curbing system liquidity given the string of failed OMO sales, hints at an attempt to lower real return on debt.
The week ahead (September 18-22) – CBN acquiescence to liquidity build-up to drive subdued pattern in yields
- In the new week, how the CBN tackles the build-up in NGN liquidity would continue to dominate sentiment across the NGN yield curve. In terms of maturities, we have NGN282bn split equally between NTB and OMO maturities.
- What can one infer from CBN’s tactics ahead of next week’s MPC? In my experience, the strongest predictor of MPR movements is CBN positioning in terms of whether it is a net issuer or net repayer. The pattern in recent weeks suggests the CBN is gearing up for a rate cut. However, I think having created a 12% threshold inflation ‘target’ at the July MPC, we are unlikely to get a symbolic rate cut in September. Importantly, given increased offshore interest the CBN is likely to want to cultivate this crowd in view of currency issues with the parallel market rates starting to diverge again though well below anything of significance. Thus, with an eye on currency, I doubt the CBN would want to send out any mixed signals on rates especially given that policy rates remain negative in real terms. Consequently, my inclination is towards an increasing pattern of net OMO repayments which have a more potent effect in driving downward yield retracement while helping the CBN keep the illusion of a hawkish monetary policy stance. Importantly is the rise in reserve levels which the CBN noted now stands at USD33bn in the media, though the 30-day average remains at USD31.8bn
- How to play the NTB auction?: As noted earlier, markets remain at the mercy of the CBN whose newfound comfort with system liquidity is in a bid to engineer lower rates. Accordingly, the 1-yr tenor is likely to continue to see strong declines as demand from pension funds for higher yields (only available at the short end) remains robust. On the other hand, CBN’s termination of 1yr OMO sales implies paper supply for the tenor is only at the NTB auction. With NGN89bn available on offer this week, I see a repeat of last week tenors and would advise caution in bid submissions. In particular, it would be advisable to wait to observe market rates a day ahead of the auction due to the presence of offshore interest in short duration Nigerian fixed income.
Over the rest of the week, I see mounting NGN liquidity continuing to apply downward pressure on rates across the yield curve. The high yield on the Sukkuk issue is likely to attract significant offshore buying interest and is likely to show the size of Islamic asset management industry in Nigeria given that we have a large Muslim population long shut out of conventional debt markets.