The first quarter of the year saw average bond yields sitting at 15.9% from 14.2% at the beginning of the year as election fears and currency weakness engendered a significant bout of portfolio outflows and tamed institutional investment in naira assets. However, yields softened to 14.7% in April following the renewed optimism that greeted the successful conduct of the elections as well as currency adjustment earlier in Q1-15.
As at the end of June, average bond yields berthed at 14.8%, roughly in line with our prognosis of 14.5%-15.0% H1-15 yield range in our January outlook report. Our anticipation of successful transition in the political landscape informed our outlook of reduced preference for shorter maturities in H1-15 compared to the trend seen in Q4-14, leaving NGN/USD and interest rate dynamics as the key determinants of yield movement in H1.
FPI inflows to naira assets waned during the first half of the year on account political uncertainty, while liquidity tightening via CRR adjustments by the CBN tempered demand by banks. However, sustained demand by PFAs and other non-bank FIs provided a floor for yields within the period.
Yields in H2-15: Outlook revised upwards
Our initial call for a softer yield environment in H2-15 seems to have been overtaken by events within the broader macro and socio-political space. A longer-than-expected bearish outlook for oil prices following persistent excess supply and the recent conclusion of the Iranian deal, the possibility of increased sovereign issuances in H2-15, expected tight fiscal and monetary conditions and possible currency adjustment are key risk factors expected to drive yields upward over H2-15.
As stated earlier in this report, we expect US Fedrate hike in September, with significant rebalancing in emerging market assets, which has the tendency to push yields upwards. We do not think the risk of exclusion of Nigeria from the JP, Morgan GBI-EM Index will materialise in the near term, as we anticipate appropriate policy responses from the CBN. Our prognosis is for average yields to close the year at 15.5%-16.0% range.
Fixed Income Strategy for H2-15: Policy to still favour short end play
The Nigerian curve is yet to fully correct though we noticed some realignment at the long end of the curve in H1-15 relative to Dec-14. In the run-up to the elections, and to some extent, post-elections, investor preference was for shorter maturities with high demand for treasuries.
We expect monetary tightening and possible currency devaluation to trigger more normalization in H2-15 especially in the mid maturity segment. While we stick to our earlier recommendation to hold less duration in 2015, we favour mild exposure at the mid maturity segment where we see rates correcting before year end. However, a longer than anticipated protraction of the current currency crisis remains a key downside risk factor.
Equities: An eventful H1
On local currency basis, Nigerian equities (NGSE) returned- 3.5% in H1-15 (vs +1.7% for emerging markets 1 and -5.4% for Frontier Markets 2). The bearish momentum which commenced from Q3-14 extended into H1-15, as declining oil prices, currency devaluation and election fears depressed equity prices. The market returned-14.7% in January due to continued volatility in exchange rate but the CBNs closure of the RDAS window renewed investors’ confidence, as stocks rallied with a positive return of +1.8% in February.
Pre-election, the Nigerian equities market had lost 11.8% YtD (as at March 27 2015). However, on the heels of the successful conduct of the polls, the market retraced to record a historic daily return of 8.3% on April 1 2015.
