Last week, President Muhammadu Buhari directed the Central Bank of Nigeria (CBN) to halt the sale of foreign exchange for food importation. This prompted front-page headlines defending CBN independence, which we believe will be heeded. However, combined with the CBN’s own pro-growth strategy, with one-year risk-free rates down 155bps in two months, we can see the effects in the main foreign exchange market, the NAFEX market, where turnover has risen steeply. This raises questions over interest rates.
The spike in foreign exchange turnover does not prompt us to worry about the Naira/US dollar exchange rate, at least not for the rest of this year. With foreign reserves of US$44.43 billion, we believe the CBN is well-positioned to sustain the Naira at current levels. In effect, the CBN has a war chest.
Bonds & T-bills
The yield on a Federal Government of Nigeria (FGN) Naira bond with 10 years to maturity rose by 24bps to 14.32%, and at 3 years increased by 164bps to 14.59% last week. The yield on a 364-day T-bill fell by 3bps to 12.17%. The yield on a T-bill with 3 months to maturity rose by 198bps to 14.28%.
The yield on the benchmark 10-yr US treasury fell below the 2-yr rate last week and this yield curve inversion sparked fears of a global recession, leading to sell-offs across key equity markets. Sell-offs also occurred in emerging money markets and fixed income markets. In the Nigerian T-bill market, bearish sentiments were towards the short end of the curve with yields on 91-day paper advancing by 198bps, while selling pressure in the bond market were evident in 3-year yields which widened by 164bps. Investors’ fear of a global recession is increasingly leading them to seek safe havens in less risky instruments rather than positions in emerging and developing markets.
The price of Brent rose by 0.19% last week to US$58.64/bbl. The average price, year-to-date, is US$65.41/bbl, 8.77% lower than the average of US$71.69/bbl in 2018, but 19.48% higher than the US$54.75/bbl average seen in 2017.
Despite OPEC’s bid to maintain tight oil supply, the market is still oversupplied and demand is weak. In its latest report, OPEC downgrades its forecast for oil demand to 1.10 million bpd, down just 0.04 million bpd from the previous month. To keep oil prices high, we should not rule out the possibility of additional supply cuts by the cartel.
The Nigerian Stock Exchange (NSE) All-Share Index lost 1.40% last week, resulting in a year-to-date return of negative 14.33%. Last week CCNN (+3.57%), MTN Nigeria (+3.05%) and Zenith Bank (+1.53%) closed positive while Stanbic IBTC (-13.39%), Unilever Nigeria (-12.81%) and Nestle Nigeria (-10.00%) fell.
Bearish sentiment was still present in the three trading sessions of last week, bringing some stocks to new 52-week lows. Most investors appear content to play in the money markets and fixed income markets where current yields are 109-351bps above inflation.
Low Naira yields for how long? (1/2)
The Nigerian economy has been growing below its potential, or at least below its 10-year average, since 2015. Price stability in the same period recorded significant gains. This a reminder that growth and price stability many times occur in sequence and seldom together.
The CBN clearly is in a mode to stimulate the economy. To achieve its growth objective it announced a rate cut in the MPR to 13.50% in March and has offered declining yields on short-term stabilisation bills since April. On the other hand, inflation has held steady at around 11% this year.
The reaction of the market to an initial compression in real yields has been two-phased. The first was indifference, in so far as yields in the global market were also trending downwards. The second phase has been a significant drop in foreign demand for OMO bills and increased pressure CBN reserves.
In 2018, a similar response to compression in real yields was observed. While yields on OMO bills held around 13% between March and June, inflation on average was slowing at an average of 69bps per month, improving the inflation-adjusted yields on these securities. However, inflation began accelerating in H2 2018 and with yields still unchanged, foreign demand began to wane – until OMO yields began to increase in September 2018.
Last year, a nearly two percentage point increase in OMO yields was the masterstroke to alleviate pressure in the FX market and restore demand for the Naira carry-trade. As a result, FPI inflows recovered to a quarter of total foreign exchange supply in the NAFEX window by October, having fallen to 17% in August. Presently, CBN reserves are down 2% in the last 30 days.
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This raises two questions. The first is whether the CBN will seek to raise market interest rates again, as it did last year. The second is whether international investors have as much appetite for Naira as they did in late 2018.