Rates decline on reduced CBN activity in money markets: Interest rates along the along the naira yield curve have receded in recent weeks driven by muted OMO bill issuance by the CBN which fueled a bullish bias as investors rushed to invest in short-dated maturities. Given relatively lower system maturities, the CBN has dialed back on OMO activity which is weighing on front-end yields. For bonds, yields have compressed around 36bps in May in particular by near dated maturities driven by renewed offshore interest in early May 2019 and a lull in selling pressures which had pushed bond yields higher over April. At the monthly bond sale, where the DMO has NGN100billion on offer, robust demand with bid-cover ratio at the highest levels since September 2017 of 2.7x (April 1.5x) contrived to drive marginal clearing rates 30bps to 14.3%. The size of the demand allowed the DMO upsize its borrowings by an extra NGN11billion.
Figure 1: Naira Yield Curve
Seasonal pressures in food drive inflation higher in April: There was a surprise uptick in inflation over April (+12bps to 11.37% y/y) driven by higher food inflation (+25bps to 13.7% y/y) as core inflation sank deeper into single digits (-18bps to 9.3% y/y). On a monthly basis, the CPI basket jumped to an eight-month high of 0.94% well shy of the 0.8% monthly average observed in Q1 2019. Though the underlying undercurrent reflects seasonal pressures in food prices as the lean season where harvest supplies are largely exhausted, the scale of the jump over April was strong and suggest some near-term upside. However, the base effects over the rest of the lean season (May-July) suggests any pressures are likely to be contained. The continued descent in core inflation which now looks set to drop into 8% will continue to anchor a subdued inflationary picture over 2019. I’m still looking for the full year average at 10.9-11.1%.
Q1 2019 GDP Report: Signs of life? The NBS put out the Q1 2019 real GDP scorecard which showed that the economy expanded 2.01% y/y which came in stronger than I had been modelling (1.8%) largely driven by a recovery in Agriculture to its 3% trend growth level and some previously comatose sectors exiting recession (real estate: +0.9%, trade: +0.8%, construction: +3.2%). Oil GDP contracted as oil production averaged 1.96mbpd vs 1.98mbpd in Q1 2018 but the reading is stronger than Q4 2018 largely due to fresh oil from the Egina oil field. This sets things up nicely for the rest of the year as oil should revert to growth as the adverse base drops off. Non-oil growth quickened to 2.5% vs 0.8% in Q1 2019 thanks to agriculture GDP returning to trend level growth as well as stronger service growth. In all, the underlying pattern would seem to suggest some upside to growth patterns over the near term as base effects over Q2-Q3 for oil production imply scope for growth to climb towards 2.5%. 2019 average should be in the region of 2.3-2.4% y/y.
Figure 2: Real GDP growth and its components
May 2019 Review: CBN throws markets a red herring: The May 2019 MPC meeting looked like it was going to be an uneventful one as the CBN was likely to play its usual wait-and-see impact approach after its surprise 50bps cut in MPR in March 2019. Indeed, the MPC held all policy parameters constant citing a desire towards supporting growth. Given the strength in oil prices, a largely benign inflation outlook (most serious forecasts for inflation put its anywhere between 10-11% over 2019), an optically healthy level FX reserves and a growing switch to policy accommodation globally, the CBN can afford to start sounding sanguine over a desire to support growth. Perhaps in this optimistic spirit, the CBN governor, fresh from his re-appointment by the Buhari government to another 5-year term, stated that the MPC would like to limit bank access to government securities in a bid to drive credit growth.
Hang on what government securities? As at April 2019, Nigerian banks held Nigerian Treasury Bill instruments issued by the FGN of around NGN2.6trillion vs NGN3.9trillion they parked in OMO bill instruments issued by the CBN. Total CBN bills outstanding by the way is a NGN17.2trillion number. In simple terms, the CBN is complaining that banks are holding too much of an instrument that it is partly supplying which is akin to a drug dealer complaining that his customers are addicted to his own dope. On a more structural level, Nigerian banks live under a policy regime which demands a 30% liquidity ratio and a 22.5% cash reserve ratio (which is effectively 30-35% across banks). Naturally, this is going to mean that a large component of bank balance sheets is always going to be warehoused in short term T-bill instruments As at April 2019, Nigerian banks had around NGN4.7trillion parked as CRR with the CBN.
Thus, between lowering CRR and reducing OMO activity you have your pick as to what levers the CBN can pull if the apex bank is serious about boosting credit growth. But can the CBN credibly do any of these in view of its long standing addiction to nominal NGN stability? This is likely where things fall apart. As such I think we should interpret the CBN governor’s proposal as no more than another diversionary spanner which the current environment allows to be tossed around till the next oil price descent resets us back to our tightening default.
Leaked tape provides hints about the CBN black hole: In between my last post, we had the pleasure of listening to a leaked tape which features a scared CBN governor fretting over the prospect of reporting negative retained earnings. Regular readers of this blog will remember that I highlighted that in the absence of a devaluation in 2018, the CBN would need to embark on monetary policy easing to balance its books. This appeared to play out in the early part of 2018 until the H2 2018 when the political noise and global sell-off proved too tempting for the CBN to ignore leading it to resume its liquidity tightening via OMO sales. The problem is all too clear to see by issuing OMO liabilities at 17-18% but having most of its non-USD assets running at single digits, the CBN was running a big mis-match on its balance that required a devaluation of its USD reserves to cover up. Between 2014 and 2017, adjusted for large FX revaluation gains of over NGN3trillion, the CBN has racked up close to NGN2.9trillion in cumulative losses. But in 2018 with no devaluation, there was simply no room to cover up the hole. if as it appears, they go ahead to publish their 2018 audited results it should reveal a gaping hole unless they rely on some creative accounting which the tape seemed to hint at. Naturally, this hole easily disappears following a naira devaluation so safe to say the next one is a matter of when not if and the CBN has at least an excuse for one when the time is right.
The week ahead (May 27-31): Looking ahead.
In the four-day trading week ahead, system maturities of NGN201billion split between NTB (33%) and OMO bills (67%) flow into the financial system. The NTB papers imply an auction on Wednesday where the CBN, on behalf of the FG, will look to refinance NGN67billion split as follows: 3M (NGN24billion), 6M( NGN3billion) and 1-year (NGN19.8billion) In addition, corporate commercial papers of NGN18billion (Mixta: NGN9.8billion, Flour Mills of Nigeria: NGN8billion) also mature over the week. In terms of events, this week sees the formal end of Buhari’s first tenure and start of his new presidential term. By luck, we should have the new cabinet quickly in place. In addition, the FGN will start the road show for a planned NGN15billion sale of green bonds.
Over the rest of the year, market attention is increasingly focused on the period leading up to Q4 2019 where monthly paper maturities cross the NGN1trillion threshold. CBN estimates place foreign holdings of OMO bill instruments at NGN5.66trillion (USD15.7billion) at the end of April 2019. This quantum implies that rates will need to remain attractive for the CBN for these maturities to be currency neutral. If external conditions appear as favourable as they are presently, the CBN might only need to raise rates by a small quantum to deal with the impact of the liquidity deluge on the yield curve. If global conditions are a replay of Q4 2018, then all bets are off the table for an upward shift in currency and interest rates.
- OMO: Open Market Operations
- CP : Commercial Paper
- DG: Deputy Governor
- NTB: Nigerian Treasury Bill
- FGN: Federal Government of Nigeria
- CBN: Central Bank of Nigeria
- DMO: Debt Management Office
- PBoC- Peoples Bank of China
- PMA: Primary Market Auction
- FAAC: Federal Accounts Allocation Committee
- I&E: Investors and Exporters Window
- MPC: Monetary Policy Committee
- NBS: National Bureau of Statistics
- REER: Real Effective Exchange Rate