Fixed Income Q2 2016: Many questions, not one complete answer

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Tuesday, June 28 2016 2:57PM /FBNQuest Research

The ultimate quandary for policymakers
The economy is contracting, inflation has surged and an experimental exchange-rate policy has just been launched.

Rather than ask themselves how they come to be confronted with this worst possible combination, policymakers somehow have to fight more than one fire at the same time.

The only positive is that the US Federal Reserve appears likely to hike its benchmark rate less often and more slowly than previously thought.

Muted tightening one solution
We expect the MPC to tighten its stance and see the policy rate at 15.00% at end-2016. It can legitimately argue that its influence is blunted in the absence of fiscal and structural reforms. Rate hikes beyond the rate of inflation, as in March, are unlikely, given the contraction of GDP.

Devaluation under another name
The CBN has exceeded all expectations with its market-driven liberalisation. There will be rewards for its boldness in the form of inflows for the interbank market but we doubt these will be substantial in the near term.

Given the modest level of official reserves, the CBN will have to trim its own supply to the market. Naira depreciation beckons therefore, and we see an end-year rate of N300 per US dollar.

Encouraging signs in fiscal policy
The 2016 budget will need to be reworked as a result of the devaluation. The FGN has taken some good steps on recurrent spending compression, non-oil revenue generation and the plugging of leakages.

If these prove inadequate, we are confident that it will rein back its capital expenditure rather than allow the sizeable projected deficit to expand.

Widening of FGN bond yields ahead
We see FGN bond yields within a range of 14.50% to 15.50% in the next quarter in the middle of the curve. The pressures of deficit financing and inflation are pushing up yields.



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