The United States Federal Reserves spooked the market on Wednesday, after it announced an increase in interest rates and hinted that two more hikes could be coming this year.
According to reports,“Ten-year U.S. Treasury note yields hit a one-week high, while two-year note yields rose to a three-week peak after the Fed’s decision to raise its benchmark overnight lending rate a quarter of a percentage point, to a range between 1.75 percent and 2 percent.”
Over the last few weeks, investors had anticipated a rate hike this week and flew to safety by dumping several emerging-market assets. A rate hike or tightening is a signal that the United States Federal Reserve (Central Bank) wants to cut back on the monetary expansion that has ensued since the global economic crisis of 2008.
Following the great recession of 2008-2010 that gripped developed markets across the world, United States, Japan, and Europe dropped rates to as low as zero percent, thereby injecting money into the banking system. Some of this cash found its way into emerging markets like Nigeria and was a major contributory factor to rise in the value of the stock market pre-oil price crashes in 2014.
Economies of developed markets have since picked up in the last two years with modest GDP Growth rates, and unemployment rates at historical lows. As stability returns to developed markets, attention has now turned towards sustainability while reducing the risk of any market melt-down due to cheap credit flowing across the world.
Reaction to FED rake hike
As the announcement of the rate hike filtered in, the United States Stock market skidded into losses, as investors pondered over the potential consequences. One such consequence is the squeeze in margins that could affect thousands of hedge funds, pension funds and mutual funds across the globe.
For example, by borrowing at interest rates of less than 0%, fund managers divert such credit into risky markets that offer yields of 4% and above, making them some nice profits. However, with the Federal Reserve now increasing rates, margins are expected to shrink, despite the fact that some of the risks remain. This perhaps is one of the reasons why investors are fleeing emerging markets like Nigeria.
How does it affect Nigeria and your investments
If you have been following events in the stock, forex and fixed income markets, then you may have noticed that we are already experiencing the consequences of this rate hike. Last May, the Nigerian Stock Market closed in negative territory for only the 8th time in over 30 years.
This resulted in a complete wipeout of the gains recorded in the stock market for the whole year. For example, Nigerian pension funds took a major hit in May from the month’s volatile stock markets, suffering a drop in their performance for the first time in a very long while, analysts at Quantitative Financial Analytics have said.
According to the analysis, the pension funds that suffered the losses are those with equity market exposure of greater than 11%, as pension funds that allocated less than 11% of their assets to equities were spared the pain.
One of the major factors for the decline is attributed to the sell-offs experienced in the hands of foreign portfolio investors who have mostly exited their positions ahead of the rate hikes.
That is not all. The Central Bank has also increased its defence of the naira by first mandating commercial banks and bureau de change operators to sell forex to Nigerians who require it for retail usage such as traveling or paying for school fees abroad. They went further and merged the rates at which FX is sold by both commercial banks and the BDCs.
Latest data from the CBN also indicates that the spate of the rising forex reserves recorded in the last few weeks has reduced with the CBN dipping its hands to fund a potential liquidity in the market.
Nigeria’s external reserves has since dipped from about $47.9 billion to about $47.4 billion.
Any reason to panic?
As opined in our series of articles covering this development, Nigeria’s economic fundamentals still remain resilient and we are cautiously optimistic that we will weather the storm. We could experience more sell-offs (even though June has largely been positive) but this could be an opportunity to pick up some of the stocks that have eluded investors since the rally that began last year.