The Nigerian stock market has been struggling for a greater part of the year. Although prices of crude seem to be going up, inflation is suddenly on the rise, the increasing size of the national debt and the apparent increase in political risk from the upcoming election may push the market further south.
On the other hand, interest rates have been inching up across all tenors even as the CBN retains interest rate at 14%. As many investors already know, when yield inches up, bond prices move down, in an opposite direction.
As bond prices drop following rising rates, investors may be presented with opportunities to add to their bond investments especially those that intend to hold such bond till maturity.
Relationship Between Interest Rate and Bond Prices
The Relationship Between Interest Rate and Bond Prices could give an indication of the right time to buy bonds. As is widely known, there is an inverse relationship between interest rate and bond prices, such that when interest rates rise, bond prices fall and vice vasa. Like everything precious, it is always in the best interest of the buyer to buy low, when prices are falling.
This relationship being played out today in the Nigerian bond market could indicate that this is a good time to buy, especially if you plan to hold them until they mature.
Interest Rates Trend Reversal in Sight
There is a clear indication that interest rates will continue to rise at a slow rate at least between now and when a new government takes hold and restores certainty, if at all. The CBN has indicated by its latest action that it may not increase interest rate any time soon given the sudden rise in inflation, but they may be forced to given the present economic health of the country.
The CBN recently warned that the economy might be heading into a recession despite the sudden increase in the price of crude oil in the world markets, inflation is suddenly on the rise, unemployment is still high, government debt, both domestic and foreign is growing, all these points to an economy at the brink.
If these fundamentals continue as they are or even weaken further, interest rates may rise the more prompting bond prices to fall further.
The rising interest rate would therefore mean that new bond issues would carry higher coupons which would be enticing to yield hunting investors.
However, if a new government comes in after the election in 2019 and presents with sound economic agenda aimed at strengthening the economy and shoring up the fundamentals, the tide may turn on interest rate. If this happens, bond prices may begin to witness an increase while yields head south.
There does not seem to be an indication that this will happen soon given hindsight and past events or history in Nigeria.
I am not completely convinced that it’s a great time to buy because interest rates seem set to continue rising, and the economy doesn’t show signs of reversing that trend, but investors could start to buy now by using a barbell strategy of bond investing.
Barbell Strategy of Bond Investing
The Barbell Strategy of Bond Investing is a strategy where investors invest in short- and long-term bonds rather than on immediate duration bonds.
This strategy is suitable in situations of rising interest rate because as the short maturity bonds mature, they are rolled over into bonds with higher interest rates. By so doing, investors will be in a good position to ride the yield curve.
There is an overwhelming agreement among bond investment analysts that trying to time the bond market could be an exercise in futility, just like trying to time the equity market. Consequently, the overwhelming agreement is that investors should know how much risk they want to and have the capacity for and then build their bond or equity portfolios that match their risk appetite and tolerance.