Fixed Income Review and Catch-Up

I would like to apologise for the radio silence over the last two months. I have assumed new responsibilities at work which bogged me down over the period. I expect this to be less so going forward and will resume regular weekly updates.

April 2023 Review

  • Tight liquidity conditions within the banking system, but higher non-bank liquidity from maturities: Financial conditions were tight over the month of April 2023, extending the trend observed since the middle of March when banks became aggregate net-borrowers from the CBN discount window which resulted in a rise in interbank rates towards 19%. At some point, aggregate bank wide SLF positions were over NGN700billion with placement rates moving to 16-17% levels having anchored at 12-13% for much of Q1 2023. These trends appear to be closely linked to the Naira re-design policy, which initially resulted in liquidity surfeit in January but reversed in March when the CBN directed banks to comply with a Supreme Court ruling. This led to higher outflows, combined with further liquidity depletions from elevated bond sales, resulting in a shortage of liquidity in the financial system and higher short-term interest rate. However, the system heaved a sigh of relief from higher non-bank liquidity from the FGN 2023 maturities.
  • Tight banking system liquidity conditions drive higher stop rates at NTB auctions: In April 2023, the Central Bank of Nigeria (CBN), on behalf of the Debt Management Office (DMO) rolled over NGN281billion worth of Nigerian Treasury Bills (NTBs) maturities, a reversal from the trend in Q1 2023 when the apex bank net issued NGN100billion worth of bills. Issuance yields were higher on average 9.8% (March: 7.6%) reflecting the tight liquidity conditions over the month. Indeed, at the first sale during the month, the CBN would sell the 1-year paper at 14.7% stop (effective yield: 19%) though the second sale saw yields crater as markets swelled up with FAAC inflows and large coupon inflows ahead of the NGN720billion FGN 2023 bond maturity.
  • Banking ‘illiquidity’ issues drives weak auction in April 2023: At the monthly bond auction, the DMO sold NGN552billion worth of bonds (down from NGN563billion in March) across the four instruments on offer (FGN 2028, 2032, 2042 and 2050s) at slightly higher average marginal rates 15% (March: 14.93%). Though the auction looks roughly similar to the March sale, the underlying picture was weak as 33% of the allotted bids were non-competitive (ie from government accounts). Indeed, demand was weak with bid-cover at 1.2x, down from the over 2x level seen at the last five auctions, as many banks prevented access from non-bank financial institutions (including pension funds) citing a desire to avoid punitive sanctions from the CBN. This development stemmed from reports about the CBN enforcing penalties on banks that accessed its discount lending windows and participated concurrently at the FGN Securities auctions. Events were not helped by the CBN on-streaming a new RTGSS payments platform that had teething issues at the onset.
  • That said, there is the counter view that the entire thing was a ploy by banks to ‘gate’ primary access to the auctions by non-banks with a view to selling their own book to these players in the secondary market. While the tight liquidity conditions over the month lend credence to the former view, the prospect of the latter view is something for the DMO to ruminate about. Indeed, the time has probably come for the DMO to re-assess the merit of the primary dealer market maker (PDMM) role for only banks in view of the sizable growth in pension funds. In advanced markets, large bidders above certain thresholds are given direct access to auctions, and this is probably the case for some large pension funds in Nigeria. In terms of numbers, the April auction brings YTD 2023 bond sales to NGN2.5trillion (36% of the target NGN7.04trillion in the budget), though adjusted for the April 2023 bond and including the net issuance on NTB paper, the DMO is around 26-27% of its 2023 target.
  • Money supply growth recovers in March 2023, as CBN complies with Supreme Court ruling: Data from the CBN on key monetary aggregates (M2 and M3) showed a broad-based expansion across with annualized growth rates of 12% (February 6.7%) and 19% (February: 13%) for M2 and M3 respectively. Central to the expansion was a recovery in currency outside banks (COB) from the multi-year low of NGN843billion in February to NGN1.4trillion in March as banks began complying with the Supreme Court ruling on to permit old notes alongside the new notes under the Naira re-design policy. After initially ignoring the ruling, following a stinging riposte from the Presidency and facing the threat of strikes by labour unions, the CBN hastened compliance which included forcing banks to open during the weekend to dispense old and new notes. From a structural perspective, growth in money supply was driven by increases across net domestic assets (+6%) and net foreign assets (+164%) with the former due to higher lending to the Government (+47% to NGN27.5trillion) and (12.7% to NGN43trillion).
  • Inflation accelerated over the month on higher core inflation: Headline inflation cleared 22% in March 2023 with increases across both food (+10bps to 24.45%) and core inflation (+102bps to 19.86%). On a monthly basis, inflationary pressures remained evident across the two components: food (+20bps to 2.1%) and core (+80bps to 1.84%) with headline CPI at 1.86%. Looking across higher energy prices (petrol: +42%, diesel: +56%, kerosene: +102%) on account of several bouts of fuel shortages underpinned the uptrend. 
  • Naira signs of strengthening? But reserves under pressure: After falling 4% over Q1 2023, external reserves continued to slide in April (down 0.7% to USD35.2billion) despite stronger oil prices and a recovery in oil production thus far in 2023. Though the CBN continues to hold the Naira stable at NGN461/$ at the now redundant IE window, sales are occurring at much weaker levels within its intervention windows (NGN550-570/$) and at the parallel market (NGN740/$). At the latter segment, rates appear to have stregntehned from the March 2023 end levels of NGN750-760/$.

The month ahead: In the month of May 2023

  • All eyes on the May 29 transition: Into the last month of the Buhari administration and focus is likely to shift on the likelihood of a presidential transition given the legal challenge to the Bola Tinubu victory snaking its way to the courts. My base case is for a transition to occur as whatever ruling (if we get one in May) will likely face another layer of legal debates at the Supreme Court which is unlikely to administer a ruling until after the handover date. As such much of the month will revolve around the policy inclinations of the incoming Tinubu administration as well as the economic management team.
  • Liquidity levels within the financial system improved at the end of April with the redemption of the FGN 2023 bond which pushed opening balances to over NGN900billion. However, this promptly induced a CRR debit by the CBN totalling NGN800billion at the end of the month which is likely to drive tight banking system liquidity. As such, this opens the vista for banks with securities holdings to sell those positions to fund their balance sheet or for pension funds who received that redemptions to either play funding or securities markets.
  • Inflation is likely to track further as the underlying drivers remain intact: higher energy costs and food prices. That said the high 2022 base suggests April print is likely to be sticky in the 22-22.1% territory.
  • In terms of securities issuance, supply at the front-end remains modest with only planned sales of NGN324billion worth of T-bills comprising NGN14.4billion worth of 91-day bills, NGN7.2billion worth of 182-day bills and NGN303billion worth of 364-day bills. Given the liquidity surfeit from the bond maturities, the front-end is likely to stay depressed from heavy demand. Farther out at the monthly bond auction, the DMO is likely to retain its NGN360billion offer across the on-the-run tenors and demand is likely to be solid especially for the longer dated tenors where yields remain over 15.5%. With renewed CRR debits, banks are unlikely to force any retracement in long-end yields ahead of the auction in a bid. Rather as noted earlier, bank liquidity will likely focus on funding rates given as yet unclear CBN stance on interest rate direction.
  • The DMO appetite for paper still remains, given the distance from its target for domestic borrowings and it will look to load up aggressively in the light of the 2023 maturity with yields under 16%. In my view, rates are likely to stay range bound at the long end though with scope for compression along the front-end but limited prospects for any retracement on the belly while the long-end should remain range-bound within a narrow range 15.4-15.6%. NTB yields are likely depressed along the 8-10% corridor.  
  • On the exchange rate, the Naira now appears on a pre-set course towards NGN550-560/$ despite the continued false stability at the IE window level of NGN461/$.  The next move is dependent on whether the incoming government moves to clear-out the present CBN leadership with a new team. If this happens then all is set for a new vista in debt and currency markets after the tortuous nine years of the Meffy Era.

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