The week that was (March 25-29): CBN surprises with a volte-face on interest rates at MPC
- The incredible rate cut: The big news last week was the 50bps surprise cut in MPR at the end of March 2019 MPC meeting. In prior week, I noted that the CBN re-introduced the 1-year OMO bill at an effective yield of 15%, a hawkish sign intended to nudge market rates higher after recent declines. Furthermore, the CBN governor dispelled all dovish notions at the sidelines of an economic conference stating that a higher inflation outlook, in his view, called for retention of the status quo. So what changed for the CBN as the argument for a rate cut has around for the last 6-12months: Disinflation, a healthy current account, favourable oil prices and a gradual recovery in the economy.
- In my view, the key change is the CBN mention about debt service. Nigeria’s federal debt service has reached alarming levels with the number now steady at 60-70% of fiscal revenues. A key driver of this metric has been the higher costs paid on domestic borrowings thanks in no small part to CBN monetary tightening. As the bond auction results showed, it would appear the FGN has switched to an emergency mode on debt service with a mandate that the CBN do all in its power to slow down the pace of that metric. Faced with this demand, but mindful of the FX implications of an overtly dovish move, the CBN governor decided to provide a symbolic rate cut of 50bps to ward off the fiscal hawks. Symbolic as in a Nigerian setting, given our high interest rates, a 25bps or 50bps move in MPR is meaningless. To move the needle, rate moves have to be around 100-200bps to be credible.
- CBN steps back from money markets, causing a dip in front-end yields: The CBN followed up with the MPC cut by stepping back from money markets with no OMO sales over the week. Liquidity over the week was tight with only NGN54billion in OMO bill maturities even as markets had to grapple with NDIC debits as well as provision for FX sales. Consequently, the CBN appeared to give markets a breather which induced a 400bps moderation in money market rates with the OVN and OBB rates settling at 10.67% and 9.86% respectively. In addition, the absence of an OMO sale drove a bullish twist as NTB rates declined strongly (-30bps w/w) with the 3M-bill down over 110bps.
- DMO forcefully ‘aligns’ bond auction result to MPR level: At the monthly bond auction, despite fairly robust demand (bid-cover at 1.5x) on the NGN100billon on offer, the DMO stunned markets by first revealing that it had NGN93billion non-competitive bids on the sidelines (as against the norm of releasing this information ahead of auction) and then clearing all three tenors at 13.5%. Basically, the DMO cleared the auction on its own terms. Since November, we have seen a pattern where the DMO largely tried to stay market neutral which then evolved into one where it sought to tactically lead the market lower. The March 2019 Auction will go down as one where the DMO directly (with no tact) engineered rates lower. The FG only took 29% of the private bids despite the volume of bids. This lends credence to my earlier point about the MPR move being a likely play by the FGN to lower borrowing costs to bring down its debt service bill.
- Nevertheless, secondary debt markets remained unmoved in the two days after the bond sale. If anything, bond markets appear to be at the early stages of a sell-off which would suggest markets do not see 13.5% as the level for bond yields over the near to medium term.
- Nigeria’s FX reserves rise to USD45billion: In recent days, Nigeria’s foreign reserves has assumed fresh upward momentum with the number rising rapidly to USD45billion (February end: USD42.4billion) as revealed in the MPC minutes. (The 30-day average risen to USD44.1billion). The fresh upside is positive for NGN outlook and likely reflects a mix of higher oil prices and renewed CBN buying activity in the spot market following the wave of FX inflows after the 2019 elections. Using 2018 imports, the current number translates to 7.5 months of import cover. Thinking of betting against the NGN? hold fire for now.
The week ahead (April 1-5): Yield downside looks likely
- In the week ahead, system liquidity picks up with relatively large inflows: maturing OMO (NGN308.72 billion), NTB (NGN97billion) and FAAC payments (NGN349billion) which will apply downward pressure on front-end rates. In the corporate space, Dana’s NGN750million bond matures on April 1, 2019. There will be an NTB auction on Wednesday where the CBN will offer NGN96billion (3M: NGN10billion, 6M: NGN17.6billion, and 1-yr: NGN68billion).
- The improved liquidity if accompanied by continued radio silence by the CBN with regards to OMO sales will drive fresh declines along the Naira yield curve especially for short term interest rates. Longer dated bonds appear to be resisting the plunge but a lower inflation outlook and limited FGN borrowings, at least until after Buhari begins his new term in June, could undergird compression in yields.
Figure 1: Naira Yield Curve
Source: FMDQ, NBS