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Yields on US 30-year Treasury debt reached the highest level in nearly 20 years as investors worried that runaway government spending, a barrage of long-term debt sales and inflation running above Fed targets for five years could spur faster policy tightening.
The interest rate on the “long bond” increased about 6 basis points to 5.31% Monday, reaching a level higher than last month’s peak and the highest level since 2007.
Comparable moves were seen in Canadian bonds, with 30-year yields climbing to the highest levels in 2010 and German debt yields at a high since 2011 in Europe.
Bondholders are also concerned about governments continuing to lose control over spending and the consequent strain on fiscal health. In addition, market structure and population trends are bringing about declining demand from predictable sources.
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Systemic ripples can occur when US benchmark bond yields (e.g., 10-year or 30-year Treasuries) soar to considerable heights. Although Nigeria has a unique capital market structure and domestic economic conditions, it’s not divorced from global liquidity flows. A hike in yields of such US benchmark bonds could trigger several ripple effects through Nigerian capital market
Nigerian bond and NTB yields would also climb as part of a policy-induced macroeconomic tightening to push down inflation, forcing local institutions to unwind positions from the equity market into the domestic fixed income market.
High US yields add pressure on the naira via strengthening the US dollar
U S. Treasuries are deemed a risk-free security; if yields in the U S rise, foreign institutional investors would have more incentive to invest in high yielding us bond as compared to Nigerian equities/ bonds and emerging market assets in general.
This will likely increase dollar demand in Nigeria’s local FX market, with the flow of foreign exchange out of the domestic environment towards the U.S economy driven by high yields, while availability falls, thereby placing severe downside pressure on the exchange rate of the Nigerian Naira.
This forces the Central Bank of Nigeria (CBN) to sell down its foreign reserves at a pace that should otherwise be unpalatable from an overall economic perspective, to prop up the Naira’s value
The typical result of elevated US yields is the strengthening of the US dollar as capital rushes to the U.S to obtain better returns (high-yield environment drives this).
A stronger greenback translates into a higher cost of servicing Nigeria’s dollar-denominated loans and its imports. The CBN often faces pressure to maintain higher local interest rates to achieve naira stability to curb rising price pressures and rein in massive capital flight and theoretically encourage uptake and holding of Naira assets. This, however, exerts downward pressure on companies’ borrowing costs as investment gets costlier, which may restrain business growth locally and exert pressure on valuations.
The effect on Nigeria Eurobonds and the cost of sovereign borrowing
Yield curves shift and spreads widen: Nigerian Eurobonds (issued by both the Federal Government and corporate entities) are used to raise international capital. When US base rates rise, the cost of borrowing internationally shifts higher, and newly issued Nigerian Eurobonds will have to be priced with higher coupons.
Nigerian Eurobond prices in international secondary markets will maly likely decline further as foreign investors require high enough yields to match the benchmark interest rates in the US. And at higher yields, Eurobonds will be too expensive in relation to international lending, placing higher reliance on the domestic debt market for fiscal deficits.
What happens to the Nigerian stock market
Typically, the participation of foreign institutional investors in Africa (including Nigeria) tends to drive the daily trading volumes, particularly of bellwether, weighty stock classes like banking, telecommunications and industrial products.
Though local participation has a huge control on Nigerian stocks, the Nigerian stock market may begin to see a stagnant or falling equity market as activity is dulled when foreign liquidity is switched off, possibly on the back of U.S. yields climbing higher.
Liquid capital is withdrawn from the Nigerian Exchange (NGX) in an atmosphere where money is rushing fast towards the safety of fixed income in the pursuit of assured high yield, making the upside of investing in Nigerian stocks limited
