Nigeria yield curve abnormal as short rates soar

Nigeria’s yield curve has inverted as short term rates soar on tighter liquidity and this may be a signal of slowing future growth expectations.

The yield curve refers to the relationship between the short  and long term interest rates of fixed income securities issued by a sovereign.

Typically, longer-dated bonds trade above shorter term bonds since investors demand a premium for lending for longer periods when economic conditions are healthy.

When investors believe there is immediate stress in the financial system, the premium demanded in the short-term rises.

“The yield curve inversion reflects continued Central Bank of Nigeria (CBN) open market operations (OMO) to squeeze liquidity; this has primarily affected the short end and ensured elevated T-bill yields,” Samir Gadio, Head of Africa strategy and FICC research at Standard Chartered said, in response to questions.

“For example, some OMOs have printed near 22 percent in recent weeks. The interpolated 6M and 12M T-bill yields are currently 19.4% and 22.5%. The authorities have allowed such attractive rates to boost the incentive to hold NGN assets domestically and potentially attract foreign portfolio investment,” Gadio said.

Such short term T-bill indicated bid yields compare to the benchmark 16.39 JAN 2022 10 year bond yielding 14.82 percent and 10.00 JUL 2030 20 year bond currently yielding 15.21 percent in the secondary market, data from the FMDQ show.

The shape of the yield curve is often used by economists and investors to gain insight about what is happening in an economy.
When the yield curve becomes inverted, profit margins fall for companies that borrow cash at short-term rates.
It may also reduce the incentive for banks to lend to the private sector as they often prefer to invest in lower-risk or risk free Government securities.
“An economy in recession needs low interest rates to discourage savings and encourage consumption and borrowing. If government treasuries are offering yields up to 16 percent or more, then the cost of borrowing will be very high for businesses which will stifle the much needed growth to restart the economy,” Oluwatosin Ojo, head of research at investment firm Cardinal Stone Partners said.
“Also, the banks clearly have little or no incentive to lend to businesses since they can get high returns from government securities. The few banks that will lend will do so at such a high interest rate that will further exert pressure on the profits of companies already grappling with FX challenges,” Ojo said.

For consumers, an inverted yield curve has an impact when their loans have interest-rate schedules that are periodically updated, based on short-term interest rates.

Many Nigerian consumers experienced this recently, when some banks sent out notifications increasing the interest rates on current loans.
Other factors may however be holding longer term bond yields down, which may not be negative for the economy.

“It may be that the market is beginning to believe the CBN will get inflation under control and that inflation will fall in the future – which is the positive interpretation,” Charles Robertson, chief economist at investment bank, Renaissance Capital said.

The CBN raised its benchmark monetary policy rate (MPR) by 200 basis points to 14 percent in July, in a bid to achieve price stability, and attract greater dollar inflows.
The move may have helped tip the yield curve into inversion, as it maintained an upward slope earlier in the year, when 12- month Treasury Bills yields traded in the low single digits and the benchmark 10 year bond hovered near 13 percent.

Nigeria’s annual inflation reached 17.1 percent in July from 16.5 percent in June – a more than ten-year high, while its economy is in recession after slumping 2.06 percent in the second quarter (Q2) of 2016, the National Bureau of Statistics (NBS), said last week.

Domestic pension funds holdings of Nigerian debt may be another factor putting a lid on long dated rates, analysts say.

“At the long end of the curve, it is unlikely that bond yields will move much higher. The Debt Management Office (DMO) will probably cap the upside for bond yields as this could result in further deterioration in medium-term domestic debt sustainability. Pension funds and institutional investors may also support the bond market as they need to match long-term assets and liabilities,” Gadio of Standard Chartered said.

An inverted curve eliminates the risk premium for long-term investments and is negative for the economy, especially at a time of recession, analysts say.
To correct the anomaly, fiscal policies must be aggressive to tackle FX scarcity through significant FX borrowing to shore up supply, rather than await FX inflows from foreign portfolio investors, according to Ojo of Cardinal Stone Partners.

“If this occurs, the CBN may relax somewhat on its aggressive mopping and allow interest rates fall. Also, fiscal stimulation is necessary – government needs to spend and pump money to key sectors to reflate the economy,” Ojo said.