Thursday, June 7, 2018 9:00AM / Zedcrest Capital
In our Previous Market outlook (Nigeria: Political Risk Brewing) published in April 2018, we advised on the need for investors to maintain a cautious outlook on the market despite the significant downtrend in FI yields which was witnessed following the significant reduction in OMO issuance rates by the CBN. We expressed a bearish outlook as we anticipated significant capital reversals from offshore players in tune to rising geopolitical risks and global financial market developments.
From the time of the report up to this moment, bond yields have risen significantly higher by c.70bps, following significant selloff from offshore investors, which has caused significant pressures in the FX market, forcing the CBN to re-evaluate its accommodative monetary stance (Liquidity easing) and to keep the benchmark interest rate unchanged at its last MPC meeting.
In this new report, we seek to review the most recent developments in the Macroeconomic and Fixed Income space and provide a view as to what factors we expect to guide investment strategy in the near term.
Macro Review and Outlook
Steady Oil Prices to Sustain GDP growth; Non-oil sector remains a drag
Nigeria’s Gross Domestic Product (GDP) grew by 1.95% (year-on-year) in real terms in the first quarter of 2018. The Oil sector contributed 9.61% to total real GDP in Q1 2018, up from 8.53% and 7.35% recorded in the Q1 2017 and Q4 2017, respectively. The Non-Oil sector contributed 90.39% to the nation’s GDP, lower than 91.47% recorded in the first quarter of 2017 and 92.65% recorded in the fourth quarter of 2017. We expect the Nigerian economy to maintain its recovery in the short-to-medium term, driven by favorable oil price and oil production. Slow growth in the non-oil sector however remains a drag on our outlook.
Rising Oil Prices threatened by expected supply pressure
Ahead of the Organization of the Petroleum Exporting Countries’ meeting in Vienna on June 22, concerns that Saudi Arabia and Russia could boost output have exerted downward pressures on oil prices, along with rising oil production in the United States. Saudi Arabia and Russia are discussing raising OPEC and non-OPEC oil output by around 1 million barrels per day (bpd), easing 17 months of strict supply curbs amid concerns that a price rally has gone too far. This development could dampen our outlook for increased revenue to government, and further accretion to the country’s External reserves.
Continued downtrend in inflation expected; Might be hampered by increased Fiscal and Election Related spend
Nigeria’s Inflation Rate declined for the 15th consecutive time to 12.48% in April from 13.34% in March 2018. This came on the back of a continued deceleration in the core index to a 27-Month low of 10.90%. We expect a continued downtrend in inflation on the back of expected moderation in food prices as we approach harvest season. The downside to this outlook however remain prospects of increased fiscal and election related spending, and waning base effects as we approach year end. Expected moderation in food inflation is also threatened by continued Herdsmen-Farmer clashes in the middle belt region. We consequently see inflation trending to lower double digits, but do not expect it to reach the CBN’s single digit target (6% - 9%) this year.
Market Review and Outlook
Exchange rate stability under pressure amid offshore selloff, Speculative positioning
The relative stability in the FX space which has been maintained for more than a year now following introduction of the I&E FX window and the significant rally in oil prices, is once again under pressure largely due to developments in the global financial markets (Monetary policy normalization in the US, a stronger US Dollar and Emerging market sell off amid rising trade tensions and geopolitical risks). These pressures are also strengthened by speculations of a devaluation of the naira, as market players weigh on risks of offshore selloff and increased demand for FX ahead of the upcoming elections.
CBN Expected to Maintain rates as downside risks heighten
Despite calls for a cut in the benchmark interest rate, we expect the CBN to keep the rates constant on the back of the aforementioned risks, even as it has continued to emphasize its strategic objective of maintaining price and FX stability. The CBN has noted the slow transmission effect of monetary policy initiatives on the real economy, with most regard to increase in lending to the private sector by the banks, and has opted to employ more of moral suasion and possible sanctions to drive compliance. We however note that consensus expectations are for a 200bps cut in the MPR before year end. We do not see this materializing, as our best case scenario is for a 100bps cut.
Offshore Selloff on Emerging Market assets remains key risk factor for Bonds
We expect that the most critical factor to the movement in bond yields this year would be the activities of the offshore players which we largely anticipate to be in either a selloff or risk neutral mode for most of the year, as they have shown preference for the shorter end of the naira yield curve in recent times. Barring an unexpected cut in the MPR or a readmission of Nigeria to the JP Morgan EM Bond index, we maintain a risk neutral- bearish outlook on bonds, with our base case for the year being a 13.50% average yield.
Continued Liquidity Tightening to keep interest rates elevated on Bills
Despite the significant drop in T-bill yields due to cut in PMA issuances and Moderation in OMO auction rates, we expect that T-bill yields would remain elevated at double digit levels (10% - 14%), as the CBN is expected to maintain its intervention in the market to mop up excess liquidity and moderate pressures in the FX space. We note that the CBN had to reverse its aggressive bullish stance on OMO following significant pressures from offshore selloff after its earlier attempt at significantly drawing down on its OMO auction volumes and rates.
More Local FGN and Corporate Issuances Expected in H2 2018
Following the significant downtrend in yields from its previous year’s highs, we expect a significant rise in corporate bond and commercial paper issuances in H2 2018, with expectations of up to N300bn or more. We also expect a further increase in FGN Bond and NTB issuances following passage of the 2018 budget. This further adds to our slightly bearish outlook on FGN yields.
From our analysis above, we note that positive developments in the domestic macro space are being threatened by downside global and domestic geopolitical and financial market risks. Our outlook is consequently benign and lacks any element of an aggressively optimistic view.
Based on our analysis and outlook, we prefer a laddered portfolio with a skew towards the shorter end of the NGN curve (T-bills), and a bias for high yield investment grade corporates.
Whilst proper and reasonable care has been taken in the preparation and accuracy of the facts and figures presented in this report, no responsibility or liability is accepted by Zedcrest Capital or its employees for any error, omission or opinion expressed herein. This report is not an investment research or a research recommendation and should not be regarded as such. The information provided herein is by no means intended to provide a sufficient basis on which to make an investment decision.