Delayed US rate cut to hurt foreign inflows into Nigeria

The U.S. Federal Reserve’s decision to push planned interest rate cuts further into the year due to higher-than-expected inflation will slow foreign investment inflows into Nigeria and negatively impact the naira.

The US Fed held rates in the 5.25 percent and 5.5 percent range leaving it unchanged for the sixth straight time at its last meeting.

Just six weeks ago, Fed Chair Jerome Powell and his colleagues pencilled in three rate cuts this year. That now looks very much in doubt.

A slew of hotter-than-expected economic data has given the Fed no reason to give the economy an assist by cutting rates after hiking them aggressively over the past two years.

Jerome Powell, the Fed chair, ruled out the possibility that the next policy move at its June meeting will be an interest rate hike.

“I think it’s unlikely that the next policy rate move will be a hike. I’d say it’s unlikely,” Powell said.

Interest rate futures have been on a wild ride in the past year, with predictions ranging from just two cuts to a staggering six.

The approach by the Fed, aimed at curbing inflation, could limit dollar inflows into Nigeria, with telling effect on the naira.

The combination of slowing growth and persistent inflation raises the risk of stagflation, a scenario the Federal Reserve is desperately trying to avoid.

Kaliba Bilala, founder of Tanabit, a financial data analytics company, said that high interest rates in the United States mean a strong dollar which is negative for developing countries such as Nigeria.

“Since the Fed is not expected to cut its interest rates because inflation is not going down as anticipated, a strong dollar will attract the flows that Nigeria and others were looking at to prop up their respective currencies,” he said.

Bilala said that FX supply to Nigeria, which is needed to prop up the naira exchange rate, may thin without additional interest rate hikes by the CBN.

Similarly Segun Adams, a research analyst at Afrinvest, said a higher for longer interest rate will affect Nigeria and other emerging markets negatively.

He said that asset managers were positioning in emerging markets at the start of the year, expecting a rate cut in June.

“Now they are reassessing their position and moving back to the US treasuries, as they are currently more attractive,” he said.

He said stronger securities mean stronger dollar and weaker currency for emerging markets.

“The outflow of dollar funds in Nigeria will put pressure on the local currency and will make the affected market less compelling,” Adams said.

The US government bond yields are at their highest levels in many years and investors who might otherwise take a risk on emerging market bonds may prefer to play it safe.

“For savers it is a blessing as risk-free US dollar bonds today offer a store of value, as long as inflation trends down,” Analysts at Coronation Asset Management said in its Nigeria Weekly Update.

Currently, the yield on the US 10-year bond is 4.62 percent while the 2-year yield is 4.98 percent. That’s very close to 2007 yields of nearly 5.0 percent on both tenors. For a decade after 2008, the 10-year yield traded mainly downwards, one reason being the monetary stimulus that followed the global financial crash of 2008.

Ifeanyi Ubah, head of research Comercio Partners said that before the Fed meeting, the Nigeria Eurobond market has priced in a rate hike due to persistent inflation concerns.

“However, the Fed’s clarification that it was only considering holding or cutting rates shifted market sentiment. As a result, the sell-off observed in the Euro bond market the previous day was replaced with improved buying sentiment,” he said

Ubah said that the nuanced reaction highlights the complex relationship between global monetary policy shifts and their effects on financial markets, with direct implications for Nigeria’s economic landscape.

“A dovish stance by the Fed would benefit Nigeria, as it would make borrowing in the Eurobond market less expensive,” Ubah said.

Ibukun Omoyeni, Sub-Saharan Africa Economist at Vetiva Capital Management Limited, said that with the Fed still considering a “hold” and possible rate cuts in future, this could make Nigeria raise funds at a less expensive rate from the international debt market.

“US treasury yields fell after the call was made. So, that’s positive for Nigeria’s June Eurobond issuance,” he said.

Jerome Powell, the US Federal Reserve Chair, said it was likely to take longer than previously expected for Fed officials to gain the “greater confidence” needed for them to kick off interest rate cuts.

“Inflation is still too high. Further progress in bringing it down is not assured and the path forward is uncertain.

“It is likely that gaining greater confidence will take longer than previously expected,” Powell said.

The Federal Reserve’s decision to hold off on rate cuts also means capital reversals for emerging markets, including Nigeria.

Nigeria enjoyed some capital inflows in February and March thanks to reforms by the Central Bank of Nigeria which included a combined 600 basis rate hike to 24.75 percent.

Foreign Portfolio Investment (FPI) began to flow back into Nigeria after the rate hike.

According to data from FMDQ, FPI net inflows increased more than ten-fold to $434 million dollars in February from $38.5 million in January. In March it further increased to $735 million.

“We think there would be a lot more of it if US rates were at the levels that they were, say, three years ago (when the US Government 2-year yield was 0.16 percent versus 4.98 percent today),” the Coronation analysts said in their report.

Nigeria also increasingly stood out for carry traders, which was a significant source of the dollar surge into Nigeria.

In April, foreign portfolio inflows began to cool as the dollar strengthened, data shows that the net inflows from the FPIs declined by 75.23 percent to $182 million in the month.