Elevated political risks and liquidity mopping activities of the Central Bank are stoking an increase in short term rates, leading to an inverted yield curve.
The yield curve had normalised in the second quarter of 2018 only to start inverting towards the end of the year.
“The yield curve is inverted because of the CBN offering OMO bills at approximately 17.6 percent at the moment, that is the one year- bills, because they are trying to suppress inflationary pressures and ensure stability of FX,’’ Nnamdi Olisaeloka, a fixed income analyst at Zedcrest Capital Limited, told Business Day on Thursday.
The fixed income analyst also raised concern about dwindling inflow of foreign capital which has caused the apex bank to push short term rates north.
“FPIs are not bringing funds, so the CBN has to increase short term rate to attract immediate flow of FX into the country to make the T-Bills more attractive to foreign investors.’’
Following the relative stabilization of FX and moderation of headline inflation which went as low as 11.14 percent mid-2018, the CBN eased its financial system liquidity approach which saw the yield curve normalise from its previously inverted position as the spread between the 10 year bond declined by -433bps to +46bps from Q3 2017 to Q2 2018.
But as the year progressed, the yield curve returned to an inverted shape.
“Between 2016 and much 2017 when the CBN was tightening via liquidity mop up and they raised short term rates, we saw an inverted curve and its same thing we are witnessing now as CBN is aggressively tightening the money market to attract FPIs,’’ said Omotola Abimbola, a Fixed Income and Forensic specialist at Ecobank.
So far in 2019, the Central bank has shown its commitment to exchange rate stability, intervening aggressively to mop up naira liquidity through its OMO auctions.
The CBN’s OMO auctions also reflects attempts by the apex bank to keep inflation on check as the minimum wage increase, elections spending and pressure on food prices among other cogent factors remain on the front burner.
Despite the consensus estimate for elevated short term rates in Q1 2019, analysts disagree on the time frame for normalisation of the yield curve.
Analysts at United Capital expect the short term rates to dip following the successful conclusion of the elections.
“A retracement in yields would likely trail the successful conclusion of the election as political risk premium normalises, especially if fundamentals are supportive.’’
However, analysts at Zedcrest Capital Limited, maintain that the yield curve would likely maintain its current inverted form throughout 2019 on the back of continued headwinds in the global economy, declining oil prices, dearth of FPI inflows, resumed uptrend in inflation, election related risks , continued OMO interventions and expected increase in domestic debt issuance.
“Given our expectations for a peaceful conduct of the forthcoming general elections, we expect yields to moderate by c.150bps in H2 19, but with the CBN still expected to maintain a tight stance on Liquidity over the course of the year, thus keeping short term rates elevated, in a bid to reign in on inflationary pressures and to maintain FX stability.’’
The analysts posited that the possible change in Central bank Governor may not change anything.
The Yield curve is consequently expected to remain inverted all through 2019, barring a significant shift in inflation dynamics or a policy re-adjustment from appointment of a new CBN Governor in June 2019.
“For us in 2019, we still expect the CBN to continue tightening monetary policy as external pressure remain with the case of policy normalisation in the US continuing at least in h1 2019 which would pressure EMFM central banks to keep short term rates up in addition to elevated political risks in the economy,’’ Abimbola said.
Abimbola also spoke about the possibility of reduced deficit financing on the part of the federal government which would drive long term yields lower.
“In addition, there is a possibility that post-elections, the FG implements supply side-price adjustment in downstream Oil and Gas and Power sector which would reduce revenue pressure and domestic borrowing. All of these imply long term rates would continue to be pressured downwards maintaining the curve inversion.’’
Ololade Akinmurele
