Bond rally may defy FG 2016 borrowing plans

Plans by Nigeria’s Federal Government to double debt issuance next year to finance its budget deficit may not be enough to interrupt the ongoing bond market rally.

Nigerian government bonds have returned 24.3 percent this year to December 8 in local currency, according to Access Bank’s bond index.

The 2016 budget draft released this week projects N1.2 trillion as domestic borrowing for next year, more than double the N570 billion of local currency borrowing embedded in the 2015 budget.

“Although net domestic issuance is likely to pick up in 2016 relative to this year, the loose monetary and liquidity stance implemented by the CBN suggests that yields could actually remain on the low side for some time,” Samir Gadio, Standard Chartered Bank’s head of Africa strategy and FICC research said in response to questions.

“We could imagine a scenario where bond yields fall even more, while the short end of the curve remains depressed, despite increased domestic issuance.”

Nigerian fixed income yields have fallen sharply across all maturities as liquidity surged on the interbank money market in recent months, due to the Central Bank’s monetary easing.

Average yields on Nigerian sovereign bonds slid to 10.32 percent on Tuesday Dec. 08 from an almost seven-month high of 16.32 percent in September.

The yield on benchmark 10-year bonds due 2022 traded at a low 11.1 percent yesterday, a level not seen since early 2013.

Investors in Nigerian government bonds questioning the sustainability of low yields may have to take a cue from the Central Bank, which is emerging as the main driver of debt prices at least in the short term.

“We think the domestic market can “soak” the N1.2trn borrowings and so do not see any major impact on yields in the short term. However, we foresee a higher yield environment sometime in Q3 if the CBN sustains its capital control measures on the FX,” Kayode Omosebi, a research analyst at United Capital , said in response to questions.

Nigerian pension funds with assets under management of N4.93 trillion will probably be major investors in any new debt issued by the government, especially at the long end, with short term yields trading below October inflation of 9.3 percent.

Pension funds allocated 63.7 percent of their total assets to Federal Government securities as at June 2015, according to data from the regulator PENCOM.

With the short end of the curve already extremely depressed in the 1-6 percent range on a discount basis, analysts say banks and pension funds could still push bond yields lower, amid supportive liquidity conditions.

“Given the unattractiveness of the equities market, coupled with the relatively low interest rates from Deposit Money Banks (DMB), we expect investors to skew towards longer term bond with seeming attractive yields,” analysts at Meristem Securities said in response to questions.

The Central Bank which is pursuing an unorthodox policy of easing rates and pumping liquidity into the system to support growth, despite the slide in oil prices (that has put pressure on the domestic currency) may not enter a tightening cycle for a while.

If bond yields overshoot on the downside, domestic market stakeholders could however be exposed to future duration losses if/when the rate cycle finally turns.

“There is a risk that bond yields back up aggressively once exchange rate considerations come to the fore and the authorities finally devalue the NGN to support the real economy and boost fiscal revenue. In March 2010, the 20-year bond printed as low as 7%, before yields backed up aggressively later that year: even though the context is somewhat different, this experience should be taken into account,” Gadio said.

PATRICK ATUANYA