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Pre MPC Note: Tightening Argument Overriding Despite Strengthening Case for Easing

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Monday, September 18, 2017/1:05 PM/ Afrinvest Research

Pre MPC Note: Tightening Argument Overriding despite Strengthening Case for Easing
The Monetary Policy Committee (MPC) is set to have its 5th meeting of the year on the 18th and 19th of September, 2017. As has been the case with all meetings held so far in 2017, we expect the committee members to maintain status quo on policy rates as they sit to deliberate on recent happenings in the global and domestic landscape next week.

However, we expect emphasis to be placed on the need to consolidate gains in the FX market whilst urging for more fiscal-monetary policy coordination to sustain recent improvements in domestic macroeconomic fundamentals. We highlight our thoughts on possible MPC considerations below.

Global Economic Conditions Still Favourable, but Medium Term Risk of Policy Tightening Persists

Since the last MPC meeting in July, the odds of a near term aggressive monetary policy tightening in advanced economies have slimmed considerably as officials of the US Fed, European Central Bank (ECB) and the Bank of England (BoE) softened hawkish rhetoric in response to economic disruption caused by natural disasters, heightening geological risk and increased uncertainty on Brexit negotiations.

Dovish comments from Central Bankers have spurred bullish bets on financial assets globally, with US equity market benchmarks reaching new record highs on Wednesday while Emerging Market high yield credit spread hit their lowest level since 2007 as bond yields fell and prices rose.

Much to the delight of commodity-exporting countries, oil prices have been on a bullish run since start of the month, after initial skepticism that the production cut agreement between OPEC/Non-OPEC countries will do little to trim global supply glut, led to bearish bets in July. The rebound in prices is driven by quick restart of US refineries after Hurricane Harvey led to a closure of major oil refineries (estimated at 20.0% of U.S refining capacity) in August as well as report by the International Energy Agency (IEA) this week which projected rising demand for oil from OECD countries.

The IEA raised its 2017 global oil demand growth estimate to 1.6mbpd from 1.5mbpd. On the supply side, recent shocks in supply volumes from the US and the lid placed on production volumes for OPEC and Non-OPEC members (ex- Nigeria and Libya) have kept prices above US$50.0bpd; hence the Brent crude currently trades at US$55.7/b as against US$48.84/b before the last MPC meeting.

Notwithstanding advanced economies’ recent cautious restraint on tightening pace and high oil prices, there are still downside risks to watch out for. The resurface of nuclear threats from North Korea, whose government have singled out the US and Japan as possible targets, will continue to rattle markets in the near term, while improving economic fundamentals in the US and EU could yet prompt hawkish comments from US Fed and ECB officials.

Slower Non-Oil Sector Growth in Q2:2017 Not Sufficient for Policy Easing

In the domestic landscape, the release of several economic data since the last MPC meeting have mirrored our current positive outlook for the Nigerian economy. The National Bureau of Statistics (NBS) released Q2:2017 GDP figures last week which confirmed expectations already formed from leading macroeconomic and market indicators such as Purchasing Managers Index (PMI) data, oil production volumes, FX liquidity and company earnings.

The report showed GDP expanded by 0.55% Y-o-Y in Q2:2017 - much in line with our estimate of 0.6% - compared to a contraction of 0.9% Y-o-Y in Q1:2017 (revised downward from earlier estimate of –0.55%). Growth was largely driven by the Oil sector which rebounded 1.6% Y-o-Y from a contraction of 15.6% in the prior year on the back of an improvement in oil output. Non-Oil sector growth however unexpectedly trimmed to 0.5% in Q2:2017 from 0.7% recorded in Q1:2017.

Whilst we are of the view that slower growth of the Non-Oil sector, despite improving FX liquidity and recent drive to boost Agriculture sector productivity, will strengthen the case for policy easing from dovish members of the MPC, we reason that the hawkish argument may be overriding given the need to sustain recent gains including increased FPI and FDI inflow.

The tightening stance is further supported by the NBS’ recently released Foreign Trade Statistics data for Q2:2017 which indicates a positive trade balance for the second consecutive quarter, albeit trade surplus slimmed Q-o-Q on account of faster growth in imports relative to exports. The report showed aggregate trade for the period summed up to N5.6tn, indicating a 37.3% increase Y-o-Y and a 7.7% increase Q-o-Q.

Trade Balance for Q2:2017 came in at a surplus of N506.5tn (N3.1tn in exports vs. N2.6tn in imports) from a deficit of N572.1tn in Q2:2016, but lower than N719.4tn surplus recorded in Q1:2017. Our outlook on trade balance remains positive given the cessation of attacks on oil & gas installations in the Niger Delta region and improvement in oil production.

Although the improvement in external sector variables and tepid growth of Non-Oil sector may impose a temptation for policy easing, yet, we believe MPC would maintain status quo next week given the need to consolidate gains on stabilizing FX and inflation rates. Our expectations are based on the following considerations:

1.       Price level remains sticky as high base effect thins out: the National Bureau of Statistics (NBS) Inflation report for August released today indicated Headline inflation marginally decelerated 3bps to 16.01% Y-o-Y from 16.04% in July. M-o-M CPI growth have remained elevated since the start of the year against the backdrop of a food price pressure which took Food Inflation to an all-time high of 20.3% in July 2017. With the economy now running out of high base effect driven moderation in headline inflation, our model projects inflation rate will rise for the first time since the start of the year in September. Given supposed price-anchored monetary policy regime, the MPC is not likely to cut benchmark rate in a period of rising inflation expectation.

2.      MPR has become a less effective Monetary Policy Tool: the case for easing via benchmark rate reduction becomes weaker if the current disparity between the benchmark rate and short-term fixed income yields is taken into consideration. More so, the Apex Bank has gradually resorted to the use of short-term instruments (OMO and T-bills) to guide the economy on a path of easing.  

While our medium term outlook favours a gradual monetary easing, we believe the stabilization of the FX market is paramount to achieving monetary policy objectives. The FX market despite improvements recorded so far in the year, it still is in a fragile state as the CBN is yet to harmonize all rates at the official market. As such, in the event that a unified rate is not achieved, monetary easing poses a threat for FX stability. Furthermore, the current realities of Nigeria’s budget deficit, suggests the need for the fiscal authorities to continuously fund this disparity which current tightening stance enhances; though at a higher cost to government. 

In light of the above, the more rational decision we foresee the MPC making is to maintain status quo and continue to consolidate on gains in the FX market. Hence, we believe the outcome of the 5th MPC meeting would be to;
•           Retain the MPR at 14.0%;

•           Retain the CRR at 22.5%;

•           Retain the Liquidity Ratio at 30.0% and

•           Retain the Asymmetric corridor at +200 and -500 basis points around the MPR. 

Global Equities Review and Outlook
As US refineries restart production in the aftermath of hurricane Harvey, oil prices rallied to touch a 5-month high of US$55.99/b on Thursday, 14th September, 2017 before declining to US$54.99/b at the close of the week. The IEA report released earlier in the week, which projected rising demand for oil, was a major driver of the rally.

In addition, despite the launch of a second missile by North Korea over Japan into the Pacific Ocean in the early hours of Friday as a form of retaliation to the United Nations sanctions against their leader, global markets appear to have shrugged off the brewing tensions as there was no noticeable impact on equity markets performance.  Sentiment was however mixed across the broad range of markets we track, with developed markets bullish whilst emerging markets and Sub-Saharan Africa equity markets were bearish.  

In the developed markets, the US NASDAQ and S&P 500 appreciated 1.4% and 1.5% W-o-W respectively, as investors’ fears with regards to expected damage by the Hurricane were tapered following the downgrade of Hurricane Irma from an expected Category 5 to Category 1. Contrarily, the UK FTSE fell 2.0% W-o-W. In the same vein, the European and Asian markets benefitted from the generally positive sentiment as all indices trended northwards W-o-W. The German DAX and France CAC grew 1.2% and 2.2% respectively. However, the Japan NIKKEI and Hong Kong Hang Seng closed the week flat, despite the missile launch threat by North Korea in the region. 

In the markets under the BRICS classification, performance was largely mixed with Brazil IBOVESPA and India BSE climbing 3.1% and 1.8% W-o-W respectively while the China SHANGHAI COMPOSITE closed flat. Contrarily, Russia RTS slid 0.5% W-o-W despite the appreciation in Oil prices while the South Africa FTSE fell 0.1% W-o-W respectively.

Performance across the African markets was largely bearish as all indices closed the week lower save for the Egypt EGX which gained 1.3%. The Nigeria All Share Index (ASI) trailed, down 2.6% W-o-W on sustained profit taking by investors in market bellwethers, followed by the Ghana GSE which plunged 2.3% W-o-W. 

Equities Market Review and Outlook
The Nigerian Bourse started the week on a bearish note, closing 81bps and 71 bps lower on Monday and Tuesday respectively. However, on Wednesday, investor sentiment strengthened as bargain hunting in large cap stocks pushed the benchmark index 19bps northwards and this was sustained on Thursday (+0.6%).  

However, the market returned to the red on Friday, down 1.8% to close the week at 35,005.57 points, implying a 2.6% decline W-o-W . Consequently, YTD return fell to 30.3% while investors lost N325.5bn as market capitalization trimmed to N12.1tn. The drag in performance was due to losses in market bellwethers - DANGCEM (-4.3%), NIGERIAN BREWERIES (-5.1%) and GUARANTY (-4.0%). In the same manner, activity level weakened as average volume and value traded contracted 19.6% and 30.3% W-o-W to 160.1m units and N3.0bn respectively.

The Oil & Gas index was the lone gainer, up 1.2% W-o-W consequent on bargain hunting in SEPLAT (+5.0%). On the flip side, the Industrial Goods index led decliners, shedding 4.4% on the back of losses in DANGCEM (-4.3%) and WAPCO (-5.3%), while the Consumer Goods index trailed, down 2.5%as a result of price depreciation in NIGERIAN BREWERIES (-5.1%). Similarly, the Banking and Insurance indices lost 2.3% and 0.3% W-o-W respectively, owing to sell offs in GUARANTY (-4.0%), ZENITH (-4.2%), LINKASSURE (-7.8%) and MANSARD (-2.6%).    

Investors’ sentiment weakened as market breadth (advancers/decliners’ ratio) declined from 0.9x in the previous week to settle at 0.6x – 22 gainers vs. 39 losers. The top performers for the week were NEM (+17.8%) CILEASING (+12.3%) and UNILEVER (+9.9%) while NEIMETH (-15.7%), SKYEBANK (-13.3%) and PRESCO (-11.6%) led laggards. In the week ahead, we expect to see some bargain hunting in early trading sessions even as investors take advantage of bargain opportunities in the market. 



Money Market Review and Outlook
In the money market this week, Open Buy Back (OBB) and Overnight (OVN) rates trended lower on all trading days despite OMO mop-ups by the Apex bank on four days in the week. On Monday OBB and OVN rate closed at 22.3% and 23.1% respectively as the CBN offered a total of N40.0bn via OMO auctions but was undersubscribed with only N7.1bn mopped up. Rates trended lower on Tuesday as OBB and OVN closed at 20.0% and 20.8% respectively even as the CBN floated yet another OMO auction (86-day and 191-day).  

Similar to the previous day, investor appetite was weak due to low liquidity, hence no sale was recorded on the 86-day instrument while the 191-day was undersubscribed. OBB and OVN rate moderated 0.7ppt and 0.8ppt on Wednesday and further declined on Thursday to settle at 10.7% and 11.3% respectively, following an OMO maturity of N156.7bn which boosted system liquidity. OBB and OVN closed the week at 11.3% and 12.2%, down 11.0% and 18.8% W-o-W. 

In the Treasury Bills market, activities at the start of the week remained pressured by tighter liquidity levels. Average rate across tenors opened the week at 17.7% but declined 4bps by the close of trade on Thursday following release of the result of T-bills PMA held mid-week which showed stop rates dropped on longer dated bills auctioned.

Sentiment stayed bullish on Friday due to improvement in liquidity and investor reaction to result of the PMA; hence, rates further dropped 7bps on average to 17.6, indicating a 21bps W-o-W decline across tenors. On Wednesday, there was a T-bills maturity worth N174.1bn which was rolled over at the PMA. The Apex bank offered N39.0bn of the 91-Day (subscription: N23.0bn, Allotment: N22.9bn), N48.5bn of the 182-Day (subscription: N25.3bn, Allotment: N25.1bn) and N86.7bn of the 364-Day (subscription: N338.9bn, Allotment: N126.1bn) instruments at marginal rates of 13.3%, 17.4% and 17.8% respectively. 

In the coming week, despite the OMO maturity of N140.9bn expected to hit the system, we expect money market rates to remain at current levels as the Apex bank continues with its frequent OMO Mop ups. 

Foreign Exchange Review and Outlook
Ahead of the 5th MPC meeting scheduled to commence next week, the Central Bank of Nigeria (CBN) has reiterated its stance towards intervening at the Interbank Foreign Exchange market. The CBN spokesperson, in a press statement, further warned speculators against “nefarious activities” whilst stating that necessary checks were in place to guard against unlawful practices. On this basis, the CBN this week, adopted the use of Electronic Certificate of Capital Implementation (eCCI) to enhance transparency and efficient processing of foreign investment inflows into the economy. 

At the Official segment of the FX market, the CBN conducted its weekly SMIS sales with US$100.0m offered at a fixed rate of N330.00/US$1.00 while Official rate pegged at N305.95/US$1.00 all through the week. At the Interbank market, the Naira 0.8% appreciation W-o-W against the Greenback to close at N355.49/US$1.00 on Friday. At the Parallel market, the Naira held steady at N367.00/US$1.00 between Monday and Wednesday but closed lower at N369.00/US$1.00 on Thursday, indicating a 1.1% depreciation W-o-W.  

At the I&E Window, activities remained robust with weekly turnover put at US$671.3m (ex-Friday) as of writing against US$705.1m recorded last week. Notwithstanding, rate opened the week at N359.50/US$1.00 and depreciated on all trading days save for Tuesday where it traded flat, to close the week at N360.25/US$1.00. 

At the FMDQ OTC Futures market, current total value of open contracts  for the 12 instruments on the calendar stood at US$2.6bn as at Thursday, 14th September, with the soon to mature SEP 20 2017 being the most subscribed at a value of U$383.30m and contract price of N358.50/US$1.00. The least subscribed remains the MAY 30 2018 instrument, currently trading at N363.33/US$1.00 with total value of subscriptions at US$42.3m. 

In the coming week, barring any surprise rate cut or comments on current administration of the FX market, we expect rates to hover around current levels at the different segments of the FX market. 

Bond Market Review and Outlook
Similar to last week’s performance, the Bond market was bullish this week as investors reacted to lower stop rates at the Treasury Bills PMA held mid-week. Consequently, yields dropped on bonds across tenors. The market started the weak slow with average yield flat at 16.9% on Monday and Tuesday despite marginal interest in the JUL 2034(-4bps), MAY 2018 (-3bps), MAR 2019 (-2bps) instruments. However, the market turned bullish on Wednesday, as average yield fell by 21bps to close at 16.7% and further by 6bps on Thursday.  

We attribute this to lower stop rates on the 181-Day and 364-Day Treasury Bills at the PMA on Wednesday. This led to increased interest in long duration bonds, with the 20-year and 15-year benchmark bond yields falling 23bps and 17bps WTD on Thursday. The bullish sentiment lingered till Friday as yields further fell 4bps on average across trading bonds to close at 16.6%, down 0.3% W-o-W.

We expect the market to pullback next week after substantial gains this week as investors take profit and free up liquidity for upcoming PMAs. During the week, the N100.0bn 7-year Sovereign Sukuk bond was opened for subscription and is expected to close on the 20th September, 2017. The instrument offers a 16.47% Rental rate and will be used for the construction and rehabilitation of key roads across the six geopolitical zones of the country. 

In a reversal of the bullish trend across the SSA Eurobonds over the past month, this week’s performance was characterized by profit taking on majority of the instruments. Yield on all instruments save for the Gabon 2017 (-12bps), Nigeria 2018 (-9bps), Senegal 2021 (-6bps) and South Africa 2020 (-2bps), declined W-o-W. Nigeria’s 2032, 2023 and 2021 bond yields rose 6bps, 4bps and 3bps to 6.5%, 5.1% and 4.3% respectively. Although we do not expect this bearish performance to be sustained, we believe investors will be looking towards the conclusions of the US FOMC meeting in the coming week. 

Performance across the Nigerian Corporate Eurobonds was mixed this week. FIRST BANK 2020 received the most buy interest (down 0.5% W-o-W to 9.0%) followed by the ACCESS 2021 (down 0.1% W-o-W to 7.3%). On the other hand, the largest DIAMOND 2019 and UBA 2022 bond yields rose 6bps apiece W-o-W to 13.8% and 7.7% respectively. DIAMOND 2019 and FIRST BANK 2021 are the best performing this year with YTD returns of +21.8% and +19.1% respectively.



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