The week that was (May 16-20)
Tight system liquidity pressures short-term interest rates, net buying on the long-end: Money markets were tight during the week on account of large outflows to fund the monthly bond auction settlements. As a result, interbank rates closed the week at the ceiling of 12.25-12.5%. (Note: In contrast to prior years when system liquidity pressures drove yields to elevated yields, CBN appears to have imposed a hard corridor on interbank lending rates which revolves around the SDF and SLF rates with the later at 12.5%). As a result of the tight liquidity conditions, banks were on aggregate net borrowers from CBN’s discount window to the tune of NGN55billion daily vs a net deposit position in the prior week. The liquidity squeeze forced a resurgence of bearish sentiments in the NT-bill space where yields closed higher in the secondary market with the 1-yr rate at 4.7%. On the flipside, the bulls returned to the FGN Bond space as likely losers from the auction sauntered into the secondary market to pick-up papers. Overall yields closed 10bps across the segment with strong buying along the belly.
Figure 1: Naira Yield Curve
Inflation accelerates over May thanks to energy and adverse base effects: The National Bureau of Statistics (NBS) released the April 2022 CPI report which showed that headline inflation quickened to 16.82% (March: 15.92%). Looking through the data, pressures were evident across the energy and core inflation segments which suggests some heightened inflationary expectations. Though petrol prices reclined over the month (-6.9% m/m to NGN172/litre), there were increases across the non-regulated fuels: diesel (+21% m/m to NGN654/litre) and kerosene (+4% m/m to NGN590/litre). Food prices remained on the up with the annualized print at 18.4%.
DMO caves in, but only slightly: At the monthly bond auction where the Debt Management Office (DMO) had NGN225billion on offer, demand improved from the weak levels seen in April with bid-cover ratio at 2.6x (April: 1.8x) especially on the long-end. The DMO took advantage of this modest improvement to sell NGN378billion worth of bonds including NGN33billion in non-competitive bids at slightly higher average borrowing rates (11.82% vs 11.8% in April). In terms of positioning, the DMO set the stop-rates on the 2025 and 2042 below the average bid yield but took advantage of market confusion along the belly to sell the 2032 just above the average bid for the tenor. Overall, a good outing for the DMO though my sense is the auction served to reiterate the theme of a slow-walk-staircase style increase in bond yields vs. a dramatic elevator style increase.
Figure 2: Primary-Secondary Bond Spread
Source: DMO, Bloomberg
YTD, net bond sales stand at NGN1trillion (Gross: NGN1.6trillion) relative to the initial budget target of NGN2.57trillion for domestic borrowings which implies the DMO is running at 39% of its target. Including the extra NGN1trillion in the supplementary budget, means there is still a long way to go and the DMO will need to raise monthly run rate from the NGN322billion thus far to a number over NGN350billion over the rest of the year.
Nigeria’s Eurobond yields now at double-digit levels, limits scope for another sale: On the sidelines of the IMF/WB Spring meetings, Nigeria’s finance minister, Zainab Ahmed had talked about another USD950million Eurobond sale over May, following the USD1.25billion issued in March. However, since that time, Nigeria’s Eurobond yields, as with the wider EM/Frontier market Eurobond spectrum, has come under strong selling with curve up 420bps YTD. The rise comes amidst reports that JP Morgan removed its overweight recommendation on Nigerian Eurobonds citing the inability of fiscal revenues to improve despite higher oil prices, given the petrol subsidy scheme. Over the last decade, Nigeria and Sub-Saharan African countries have taken advantage of easy money policies across advanced climes to borrow at cheap rates. The inflation across advanced countries and the resulting shift to tight monetary policies suggest that era is over and countries will either need to face Bretton Wood agencies for USD financing or increase issuance across their local currency debt markets.
Figure 3: Nigeria Eurobond Yield Curve
Naira plunges further outside the official market, FX reserves decline: At the official segment, the Naira remained official stable at NGN419/$ though as I have maintained actual dollar liquidity remains patchy. came under a fresh bout of weakness over the week. At the unofficial market, the Naira fell further to NGN606/$ as dollar liquidity thinned out across the financial system. Despite oil prices remaining above $100/bbl, Nigeria’s external reserves declined 1.5% w/w to USD38.8billion, the lowest level since October 2021, as the fuel subsidy continued to filter out oil export flows to the CBN. This downward spiral is unlikely to meet any resistance as the CBN has broken the link between the official USD flows and the informal economy via its proscription on USD sales to BDC operators. Additional demand is likely to emanate from the political sector ahead of a testy primary season over the last few days of May. The CBN knows what needs to be done: Normalise monetary policy, end this heterodox experiment!
The week that was (May 23-27)
With no major inflows, system liquidity is likely to be tight which continue to exert upward pressure on short-term interest rates. Market focus is likely to be on the two-day monetary policy committee (MPC) meeting which concludes on Tuesday. In addition, there will be an NTB auction on Wednesday where the CBN, on behalf of the DMO, will look to sell NGN153billion. The 1-yr should continue its slow-walk towards 5%.
CBN likely to hike interest rates in a symbolic move: At the May 2022 MPC meeting, key data points suggest the CBN has likely run out of excuses to avoid hiking interest rates. Inflation now looks headed in an upward direction as even when adjusted for energy and food price pressures, the underlying ‘core’ inflation is running at 14%. On the growth front, the NBS is likely to put out a Q1 2022 GDP report which should show strong non-oil output though production headaches should keep the oil sector in recession. On the currency front, the rise in global interest rates and the plunge in the Naira at the unofficial market will likely reinforce the need for tighter monetary policy. (Admittedly the CBN will continue to publicly refuse to acknowledge the parallel market rate). All these points are likely to push more members of the MPC (which voted 6-4 to hold rates) to turn hawkish. As I discussed last week, among the dissenters were two CBN insiders meaning we only need the remaining two independents to move over.
Overall, I see scope for 100-150basis point in the key Monetary Policy Rate (MPR) to be likely accompanied by some adjustments to the corridor around MPR towards a symmetric corridor of 200bps vs the current asymmetric corridor of -700/+100bps.
Since 2019, the CBN seems have latched on to the idea that high interest rates does not solve anything, rather dealing with structural issues was key given the supply side nature of inflation. While this argument has merit, the CBN also needs to consider that interest rate policy also has significant implications for exchange rate management. All monetary policy decisions must constantly seek to achieve some optimal position from an impossible trinity perspective. Trying to ignore powerful economic laws under an ambitious plan to fix longstanding structural issues requires strong fiscal coordination to minimize potential downside risks to price stability. Unless you have credible fiscal policy execution, attempting to do it alone as we have seen over the last 3-4years is likely to be a futile effort. Rather than risk digging, the CBN needs to row back towards the path of normalcy.
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