Last week, we discussed the performance of the equities market and stated that it is time to give Nigerian stocks another look. Today, we look at the trends in the fixed income market and expand on why we think fixed income will remain not an easy sell unless under the heading ‘You have nowhere else to go’.
Last week, the exchange rate at the Investors and Exporters Window (I&E Window) appreciated by 0.37% to N413.38/US$1. Elsewhere, the Central Bank of Nigeria’s FX reserves rose by 1.35% WTD to US$36.60bn (29 September 2021) – the highest level since 12 February 2020 – signifying the sixth consecutive weekly accretion. In our view, the reserves partially reflect the International Monetary Fund’s (IMF) Special Drawing Rights (SDR) allocation to Nigeria. In addition, the FGN also successfully raised US$4.00bn in Eurobonds last month. This will be banked with the CBN and should see the reserves rise to above US$40.00bn over the next few weeks, enough to provide the apex bank with enough ammunition to defend the Naira in the short term. Nevertheless, FX turnover on the official markers remains relatively low. Thus, there may be continued pressure on the official and parallel exchange rates if the CBN does not increase supply.
Bonds & T-bills
Last week, sentiments in the Federal Government of Nigeria (FGN) bond market were mixed with a bullish tilt, as demand at the top of the week, following much-improved system liquidity, offset the primary auction result-induced selloffs. Consequently, the average benchmark yield for bonds fell by 3bps w/w to close at 11.20%. The yield of an FGN Naira-denominated bond with 10-years to maturity was flat at 12.02%. However, the yield on the 7-year bond fell by 5bps to 11.55%, and the yield on the 3-year bond fell by 32bps to 8.83%. We reiterate our view that a future rise in bond yields, if any, is unlikely to be sharp over the coming months due to unaggressive borrowing as the DMO manages its debt service costs.
Trading in the Treasury Bill (T-Bill) secondary market was bullish as inflows from the monthly federal disbursements to states and local governments (c.N360bn) and OMO maturities boosted system liquidity. As a result, the average benchmark yield for T-bills fell by 32bps w/w to 5.29%, with demand concentrated at the mid-segment of the curve. Elsewhere, the average yield for OMO bills declined by 11bps in the week to close at 6.32%. Specifically, the annualised yield on a 343-day T-bill fell by 81bps to 7.49%, while the yield on a 320-day OMO bill rose 12bps to 7.53%. At the T-bill primary market auction (PMA), the DMO allotted N115.01 billion (US$279.84m) worth of bills across all tenors. Accordingly, stop rates remained unchanged on the 91-day (2.50%) and the 181-day (3.50%) bills, while the rate on the 364-day bill rose by 30bps to 7.50% (8.11% annualised yield). Notably, demand at the auction was relatively weak, with a total subscription of N174.74bn – the lowest level since April 2021 – and a bid-to-offer ratio of 1.56x (vs an average of 4.30x over the last six months).
The price of Brent crude rose by 1.52% last week to close at a US$79.28/bbl. Year-to-date, Brent is up 53.05% and has traded at an average price of US$68.05/bbl, 57.46% higher than the average of US$43.22/bbl in 2020. The price rallied – and almost hit US$80.00/bbl – amidst supply concerns around Hurricane Ida’s disruptions and some Organization of the Petroleum Exporting Countries (OPEC) members inability to significantly increase production as oil demand picks up with the easing of pandemic restrictions across the globe. However, production in the Gulf returning close to levels reached before the hurricane and power crisis and housing market concerns in China put a ceiling on the oil price. Today, OPEC+ are scheduled to meet as the group faces pressure from some countries to produce more to help lower prices since demand has recovered faster than expected in certain parts of the world. Nonetheless, we reiterate our view that the price of Brent oil is likely to remain well above the US$60.00/bbl mark for several months.
The NGX All-Share Index (NGX-ASI) surged by 3.23% last week, the largest weekly gain since the week has ended 29 January 2021, to close at 40,221.17 points. Notably, the index crossed the 40,000 psychological mark to hit its highest level since 24 February 2021, almost erasing all its losses for the year (YTD: -0.12%). Dangote Cement +14.29%, Presco +9.93%, FBNH +7.33% and Nestle Nigeria +5.71% closed positive last week, while BUA Cement -2.94%, FCMB Group -2.36%, Guinness Nigeria -1.33% and Honeywell Flour Mills -1.05% closed negative. Sectoral performances were bullish as the NGX Industrial led the gainers, rising by +6.65%, followed by NGX Consumer Goods +3.35%, NGX Oil & Gas +0.92% and NGX Banking +0.60% indices. Conversely, the NGX Insurance index declined by -7.58%.
Nigerian fixed Income Remains a Tough Sell
This year, the theme for the fixed income markets has been spread widening, with the average yield of FGN bonds expanding by 508bps YTD and the average yield on Treasury Bills (T-bills) expanding 482bps YTD. Yields on the CBN’s OMO bills have also followed a similar trajectory, rising by 581bps YTD. The widening was much more significant in the middle of Q2 2021. However, yields reversed from that point on.
Overall, the widening came as investors continued to demand higher yields at auctions amidst surging inflation. Other factors that influenced yields include the squeeze in system liquidity (see Coronation Research, Interest rates and banks’ margins), reducing participation from institutional investors (who preferred higher-yielding fixed deposits), and the federal government’s significant deficit financing needs this year.
Where do we go from here? On the demand side, N1.59trn [T-bills (N610.30bn), OMO bills(N750.90bn) and FGN coupon payments (N224.91bn)] worth of instruments will mature and contribute to system liquidity in Q4-21. Additionally, as monthly contributions grow, demand from Pension Fund Administrators (PFA) is likely to remain strong. PFAs have approx. N13trn in assets under management with about N7.65trn (64% of AUM) invested in government securities.
On the supply side, we highlight that the federal government planned to raise a total of N2.34trn in domestic debt to fund its budget deficit for 2021. As of end-Q3 2021, the government has raised 102% of its target for the year and is not likely to be under significant pressure to increase its local debt stock over the rest of the year.
In our view, yields seem to have hit the ceiling or resistance at current levels. If any, a future rise in yields is unlikely to be sharp over the rest of the year. With the monetary authorities still mainly concerned with driving growth, it seems clear that they have finished with the effective tightening of market interest rates that characterised the first half of the year. Thus, for the time being, they seem content to see 1-year yields substantially below 10.0% and average bond yields below 12%.