The weeks that were (February 15-March 5)
Apologies for the three-week hiatus, but back to regular programming. In between yields continued to move higher, in line with global bond yields sell-off, on concerns over higher fiscal issuance. But my suspicion is that more fundamental factors could start to re-assert themselves on market movements.
Forced sellers and a short overhang drive bond yields higher: Since my last update FGN bond yields climbed on average 49bps (YTD: +390bps) underpinned by a mix of pension fund selling and an overhang of shorts (banks and asset managers). Frantic pension fund sales were in response to a regulatory deadline (March 4, 2021) to streamline exposure to FGN bonds booked at fair value. The existence of these desperate sellers fuelled strong shorting action by banks and asset managers (who can short sell bonds vs. pension funds who are restricted) which served to push bond yields higher ahead of the February bond auction. With the pension fund sellers done by March, bond yields slackened in early March with the market looking for direction.
On the front end, yields remain subdued, though have gradually moved up in tandem with the outcome of the NTB auctions. The CBN rolled over its Special bills which matured on March 1 first at 2% then reversed it to 0.5%. The development is linked to technical difficulties arising from the existence of non-bank holders who needed the cash payments.
Figure 1: NGN Yield Curve
Source: FMDQ, NBS
Short-squeeze tempers things after underwhelming bond auction: At the February bond auction, the DMO elected to under allot to the market (43% of bids) but still filled its borrowing plan (136% of offer) by relying on large non-competitive bids (NCBs). As I noted last month, the DMO posture appears to suggest it has reserves of these NCBs which are on track to print above the 2020 total. This forced many bond shorts to have to cover their position by buying back in the secondary market which has helped drive a retracement in yields from the bond auction levels.
Figure 2: Non-competitive bids
Source: DMO *Jan-Feb
Nigeria exits recession, but outside chance of a double-dip: The Nigerian Bureau of Statistics (NBS) revealed that Nigeria’s economy grew by 0.11% in Q4 2020, which tracks well ahead of most forecasts (including mine) which only expected an exit in Q2 2021. Though compliance with OPEC cuts weighed on oil output (down to 1.56mbpd) leaving the sector in contraction (-19% y/y), a pick-up in growth across Agriculture, lesser contraction in trade, continued double digit growth in telecoms and a surprise expansion in real estate helped swing the pendulum back to growth.
Figure 2: Nigeria GDP
Looking ahead, while the odds are high that Nigeria should experience growth over 2021 with consensus forecasts hovering around 1.5-2%, I would wager that the chances of a return to contraction in Q1 2021 are non-trivial. Central to this, is the likely deceleration in telecoms growth following the line deactivations and suspension on sim card sales effected in December. Active phone lines are down by over 7m from November levels. Furthermore, Nigeria’s oil output plunged to record lows in January following some disruption along the Qua Iboe terminal. Alongside soft growth in other sectors, there is an outside chance of a return to negative trends in GDP over Q1 2021 but I expect this to be short-lived and that normalcy will return. More like a W-shaped recovery
Inflation fires up in January, but monthly print suggests a slowdown: Headline inflation continued to track higher, rising to 16.47% y/y (Dec: 15.75%) driven by continued increases in food inflation which rose to 20.57% (Dec: 19.56%) relative to a modest rise in core inflation to 11.85% (Dec: 11.37%). The monthly readings however showed a different pattern as headline CPI growth slowed to 1.49% vs. 1.61% in December driven by a deceleration in rural food inflation. Looking back at food prices, the shocks to food supply from October 2020, when the #ENDSARS protests occurred, now appear to be dissipated. My outlook for inflation is for further upside towards 18% levels before base effects drive a sluggish deceleration towards 15% by year end 2020. Central to this view is the cumulative effect of shocks to fuel and electricity prices, currency weakness and lingering food price pressures.
Figure 3: 2021 Inflation forecast
Source: Authors calculation
CBN’s completes the peg shift, introduces Naira4dollar promo to lure remittances: As I noted in an earlier post, when the CBN moved OMO rates to 10% and weakened the NDF futures, the Naira was on a preset course to NGN410/$. Indeed, the Naira completed a slow dance routine to NGN410/$ in early March with confirmation by the CBN governor that it had devalued the exchange rate. Over the weekend the CBN introduced a scheme designed to pay NGN5 for every $1 remitted through official remittance channels. The policy looks like a version of a successful scheme introduced by the Bangladesh Central Bank to bolster remittance inflows over the covid-19 era. Effectively, the CBN is paying 1.25% to defray the cost faced by users who remit inflows via IMTOs in a bid to boost ‘wired’ USD liquidity.
The end of OMO? Rounding up, a CBN director (Hassan Mahmud) in the monetary policy department stated that the apex bank was on course to phase out the OMO carry trade enjoyed by foreign investors (now barred to local non-bank investors) citing a desire to cut costs associated with the operation. No sooner had this story hit the wires did CBN issue a rebuttal of the entire event. However, after the record unwinding over 2020, when the CBN kicked out non-bank OMO investors and cut back its OMO book by NGN5.5-6trillion, it has continued to redeem OMO bills with a further reduction NGN1.1trillion over Jan-Feb despite moving rates higher. This would appear to suggest that while there is some truth to Mr. Mahmud’s claims, this possibly reflects a medium term view than something imminent. As you were then!
The Week ahead (March 8-12, 2021)
In the week ahead, system maturities are thinner relative to recent trends with only NGN85billion in NTB maturities and OMO maturities at NGN60billion. Though market sentiment is being dominated by bearish sentiments on the prospect of higher debt issuance, the demand supply dynamics are shaping up differently over the near term.
Near term impetus likely to shift towards demand as front-end primary market supply wanes: On the supply side, CBN issuance should decline with no OMO maturity from the end of March to May 31st when curiously the NGN4.2trillion Special Bills matures. Furthermore, NTB maturities drop off from the Q1 elevated levels. This means short term securities supply will need to be driven by secondary market developments unless the CBN decides to maintain issuance over the period (this will be a tightening signal). On the bond side, the DMO is likely to continue reliance on non-competitive bids and under-allotments to in a bid to force markets to re-adjust at the primary auction implying more events as in February. With no desperate pension fund sellers, secondary market supply at the long end will be soft. On the demand side, pension funds have ample maturities and are likely to rotate out of other asset classes to position for the prospect of higher interest rates. However, duration apathy will likely persist until yields reach 13-14% levels which means the front-end and possibly the belly of the curve could see buying action. Who breaks first in the staring game? My suspicion is that demand will respond aggressively the closer we get to July (when there are large system maturities) which could send yields lower.