The drop in inflation to 9.0 percent y/y in Jan, from 12.0 percent y/y in Dec, was somewhat more significant than expected by the market, precipitating a new leg down in rates at the short end and some initial compression in bond rates. Indeed, T-bill yields fell by around 100 bps in the secondary market after the last CPI figure was released on 18 Feb, temporarily breaking the 10 percent threshold for some of the longest maturities. Meanwhile, bond rates dropped by about 30 bps, with the Jan 22s trading as low as 10.4 percent on 20 Feb. Prior to this, the four bonds on offer at the 13 Feb auction were issued with a sub-11 percent angle (10.67 percent [April 17s], 10.96 percent [June 19s], 10.80 percent [Jan 22s], 10.90 percent [Jul 30s]) as the market positioned for an imminent single-digit CPI print.
A more nuanced picture has however emerged in the T-bill market in recent days. On one hand, the yield on the 364-d instrument has reverted to double-digit levels (11.0 percent on 8 March) in the secondary market. On the other hand, the very short end of the T-bill curve first backed up, but then shifted down slightly amid less aggressive open market operations (OMOs) carried out by the Central Bank of Nigeria (CBN) and also more interest in this portion of the curve. As a result, the T-bill curve has now disinverted and flattened.
Still, the irony is also the disconnect between where T-bill rates printed at the 6 March auction in the 3-m and 6-m portion of the curve and secondary market levels. Indeed, the 91-d and 182-d instruments are trading well above the latest primary market yields (9.4 percent and 9.9 percent, respectively) while the 364-d tenor trades broadly in line. Perhaps this reflects the differentiated investor base at those various maturities since retail clients tend to largely participate in the 91-d and 182-d auctions and will not necessarily bid aggressively or depart from previous primary market rates.
Overall, the bid for Nigerian T-bills should still be relatively well supported assuming we revert to a more constructive global risk environment going forward. Because foreign investors now account for a meaningful share of domestic T-bill holdings, this part of the yield curve is increasingly exposed to external factors and offshore market sentiment. Although concerns about an earlier-than-expected retreat from monetary stimulus in the US put pressure on a number of asset classes in Feb, this however did not lead to a foreign exit from Nigeria. With FED Chairman Ben Bernanke now suggesting monetary policy will remain loose for longer and that the central bank’s bond purchase programme will continue until a material improvement in the US economy becomes tangible, we suspect there will still be decent foreign interest in the carry trade in Nigeria, even at lower yields than in 2012. In any case, there are few emerging- and frontier-markets that can deliver a similar carry, especially if one accounts for secondary market liquidity and USD/NGN stability.
On the domestic front, local investors are likely to stick to their holdings at the short end if there is still decent foreign appetite – albeit not as substantial as last year – for T-bills. The shape of the T-bill curve is also to a large extent dependent on the CBN’s tolerance for excess liquidity and the subsequent magnitude and cut-off rates of its OMOs (10.79 percent [114-d] and 10.87 percent [121-d] on 5 March). This in turn is a function of the trajectory of USD/NGN since the CBN is unlikely to tighten liquidity conditions aggressively as long as the exchange rate remains resilient.
Meanwhile, bond yields have failed to break the 10 percent threshold and trended upwards lately, with the Jan 22s reaching 11.3 percent on 8 March. This is despite the favourable CPI outlook for Q1:13 (9.7 percent and 9.3 percent projected for Feb and March), the expectation for more subdued issuance volumes from March and the forthcoming inclusion of selected maturities in the Barclays Emerging Markets Local Currency index. The rebound in secondary market rates at the long end probably also mirrors the less supportive risk momentum that may have pushed some offshore investors to lighten up duration and/or reallocate funds to the short end.
At the same time, local investors and pension funds feel that single-digit yields are not representa tive of Nigeria’s long-term double-digit inflation path and most likely pushed up rates in recent days as the foreign bid receded. Domestic investors still remember the painful losses incurred in 2010 as the yield curve shifted up sharply following a period of qualitatively low rates which would also explain their cautious stance this time.
While the CBN has already eased effective monetary conditions as illustrated by the substantially lower OMO cut-off rates over the past 12 months, a cut in the Monetary Policy Rate (MPR) – which would have provided more support for bonds – looks unlikely for now given the still loose federally consolidated fiscal stance and the increase in the oil price benchmark to USD79 pbl in the 2013 budget. We suspect the Monetary Policy Committee of the CBN will maintain the MPR unchanged at 12 percent at the 18/19 March meeting and if any hypothetical reduction in the policy rate occurs later this year, it is likely to be only symbolic and designed to show that the central bank is predisposed to support the real economy. Should the current correction in the bond market continue in coming days, the 13 March auction (NGN35bn of April 17s and NGN35bn of Jan 22s) may well generate more attractive re-entry levels at the long end.
On the FX front, USD/NGN drifted marginally higher and broke the 158 level on 27 Feb to peak at a four-month high of 158.4 on 28 Feb. There were market reports suggesting that foreign inflows had slowed somewhat in Feb in line with the relatively more risk-averse international environment over the period which ultimately put upward pressure on the pair. Besides, the downward trend in the Bonny Light oil price, which retreated to USD112.9 pbl on 4 March, from USD120.5 pbl on 8 Feb, also added to the negative momentum.
That said, the stabilization in global markets over the past few days has been associated with more favourable oil price metrics. The Bonny Light is now trading at USD114.0 pbl (8 March), slightly above the average recorded between Aug 2012 and Jan 2013 (USD112.5 pbl). Meanwhile, the exchange rate (157.8 on 8 March) has hovered around the 158 mark lately (vs an effective WDAS rate of 157.3) which implies that the new interbank USD/NGN equilibrium has moved up modestly as foreign portfolio flows reduced. The NGN is still supported by FX sales from oil companies, but more importantly, the CBN stepped in and raised the amounts on offer at the Wholesale Dutch Auction System (WDAS) sales up to USD200.0m and USD234.9m on 27 Feb and 4 March. Given the steady pick up in foreign reserves since early 2012 (USD47.6bn on 4 March), the CBN has enough ammunition to address a temporary demand-supply mismatch in the FX market. As long as the correction in various asset classes witnessed in Feb dissipates and does not lead to capital outflows, the CBN will probably remain broadly comfortable with the mild uptick in USD/NGN and will not rely on the interest rate mechanism to tighten NGN liquidity. While the exchange rate assumption in the 2013 budget is 160, the central bank does not appear to be in a rush to synchronise its USD/NGN 155 FX midpoint, and even if it did, the current WDAS rate would still be at the lower end of the new +-3 percent range around 160.
The Nigerian Stock Exchange’s All-Share Index gained 18.3 percent YTD (as of 8 March), initially underpinned by declining interest rates domestically and positive global liquidity conditions, even though it has lost ground since late Feb. While more weakness or at least a period of consolidation may well be in the pipeline in the short term, we are still bullish on the medium-to-long term outlook for the bourse. After all local pension funds and institutional investors are largely underweight equities at the moment and the next release of corporate results may potentially be a catalyst for further foreign participation assuming expectations are met and offshore sentiment remains supportive.
Finally, the Nigerian Eurobond also came under pressure, with the instrument losing almost seven points earlier this year (a low of 115.4 on 26 Feb from 121.4 on 8 Jan). Clearly this poor performance tracked the market correction in the Eurobond space in the same timeframe and a period of relative risk aversion, but a more balanced momentum recently was conducive for a recovery in the 21s which traded up to 118.0 on 8 March (a yield of 4.1 percent). Should a constructive risk profile re-emerge in coming weeks, the 21s will probably initially gain marginally, but the tight spread (233 bps vs 282 bps for EMBI+) makes a sustained long position hazardous, not least because any further increase in US treasury yields on the back of positive economic news would either neutralize or even weigh negatively on the valuations of the Nigerian Eurobond.
SAMIR GADIO
