Saturday, April 08, 2017 04.31AM / FSDH Monthly Outlook
· The Nigerian economy is showing signs of positive outlook on the back of increase in oil price, oil production and increase in the supply of foreign exchange to both retail and corporate users
· The Federal Open Market Committee (FOMC) of the United States Federal Reserve (The Fed) indicates that it may increase the interest rate further in 2017
· The Organisation of Petroleum Exporting Countries (OPEC) maintains its global economic growth forecast for 2017
· The inflation rate dropped in February 2017 for the first time in 15 months. Our forecast shows that it will drop further in March 2017
· The external reserves continues to grow due to increase in oil production and price
· The yield on the shortest tenor on the Nigerian Treasury Bill (NTB) dropped in March 2017, while that of the longest tenor increased. The expected drop in inflation rate may make it to drop further for all tenors. Meanwhile, the funding for foreign exchange supply may drive up liquidity and limit the extent of the drop in yield
· Improved investors’ confidence may make the equity market to appreciate in April 2017.
1.0 Global Developments
In the countries we monitored, the prices of government bonds appreciated in more countries in March 2017 than they depreciated.
The 16.39% January 2022 Nigeria Government Bond and the 7.60% April 2021 Russia Government Bond recorded the highest month-on-month price increases of 1.35% and 1.28% to 102.41 and 99.05, respectively. The 17% April 2022 Egypt Government Bond recorded a month-on-month price decrease of 0.98% to 99.49. This was followed by the 8.80% September 2023 Turkey Government Bond with a marginal decrease of 0.77% to 90.80. The Egypt, Nigeria, United States (U.S.) and Turkey Bonds closed the month at negative real yields. Other bonds we monitored closed the month at positive real yields. The Russia Government Bond offers the most attractive real yield amongst the selected bonds in March 2017.
According to the final figures that the United States (U.S.) Bureau of Economic Analysis released, the US economy grew by 2.1% in Q4 2016 (quarter-on-quarter), higher than 1.9% in the previous estimates. Consumer spending and inventories increased faster than anticipated while investment moderated lower and weighed down growth. In 2016, the GDP grew by 1.6%, the lowest since 2011. The inflation rate in the U.S stood at 2.7% (year-on-year) in February 2017, from 2.5% in January 2017 and in line with market expectations. It was the highest inflation rate since March 2012, boosted by a rise in gasoline prices. The Federal Open Market Committee (FOMC) of the U.S Federal Reserves increased the Fed Rate by 0.25% to a range of 0.75%-1.00% in March 2017.
1.1 The Global GDP
The Organization of the Petroleum Exporting Countries (OPEC) maintained its global growth forecast of 3.0% and 3.2% for 2016 and 2017, respectively in its monthly report for March 2017. OPEC posited that global economic growth has stabilised and the estimated growth dynamic is consistent with its previous views. It added that the Organization for Economic Cooperation and Development (OECD) economies are expected to grow by 1.9% in 2017. The OECD growth may come from fiscal stimulus in the U.S but the magnitude and timeline of this remain uncertain.
OPEC noted that India and China will lead growth in the emerging and developing economies. Growth in India may improve after the impact of demonetisation has been digested. China has reiterated its intention to target a higher growth level than is currently accommodated for in the global growth forecast. The stabilisation of the oil market is also supporting global growth, as oil producers are now benefitting from a recovery in output values and once again rising oil sector related investments.
The cartel however says that the policy issues across the globe and monetary policy decisions of the major central banks are the major uncertainties the global economy faces. It also noted that the monetary policy tightening will continue in the U.S. This may also apply to other major central banks, though a relatively more accommodative stance is expected from some central banks, particularly the European Central Bank (ECB) and the Bank of Japan (BoJ). Global debt levels remain high in some key economies, an issue that will probably require further attention as interest rates may rise gradually and the U.S Dollar may continue to strengthen because of the rising inflation rate.
1.2 FOMC Rate Decision:
The Federal Open Market Committee (FOMC) of the U.S. Federal Reserve (The Fed) raised the Federal Funds Rate (Fed Rate) by 0.25% to 0.75%-1.0% at its March 2017 meeting and indicated an accelerated pace of increase over time. There are indications that the FOMC will increase the Fed Rate further in 2017, as the Fed’s median projection in 2017 is 1.4%. The implication of the rate hike in the U.S is that yields on Dollar denominated fixed income securities may rise. This may lead to capital flight from emerging markets to the U.S, and cause an appreciation in the value of the U.S Dollar.
This may also lead to a drop in the price of crude oil – Nigeria’s main foreign exchange earner. The possible increase in shale oil production is another factor that may put downward pressure on crude oil prices.
The implications of the rate hike in the U.S are highlighted below:
· Flow of funds to the U.S. from emerging markets and developing countries.
· Appreciation of the U.S. Dollar.
· Downward pressure on commodity prices.
· Increase in the yields on the Dollar denominated fixed income securities.
· Increase in the cost of fund from the international debt market.
· Drop in the global liquidity.
1.3 Foreign Trade:
The Nigerian economy recorded a trade deficit in 2016. This is contained in the NBS Merchandise Trade Intensity Index/Re-exports, Q4 2016. The economy recorded a trade deficit of N290bn in its merchandise trade in 2016, from the trade surplus of N2.90trn recorded in 2015. In 2016, Nigeria’s total trade stood at N17.34trn, an increase of 6.47% from N16.29trn recorded in 2015. Exports recorded a decrease of 11.05% to N8.53trn in 2016, from N9.59trn in 2015. On the average, exports accounted for about 60.98% of the total trade in the last four years, while imports accounted for 39.02%.
The drop in the oil price led to trade deficit recorded in 2016. The trade deficit has contributed to the shortage of foreign exchange. With the improvement in both oil price and production, we expect the country to record trade surplus going forward.
1.4 Inflation Rate:
Whist the inflation rate dropped in February 2017 to 17.78% (the first drop in 15 months) as a result of a base effect, we note that the month-on-month change of 1.49% was the highest increase since July 2016. This means that inflationary pressure persists in Nigeria.
The inflation rate in February 2017 was driven by the faster growth in all major divisions of the Headline Index. Year-on-year (y-o-y), the Food Price Index (FPI) increased by 18.53% in February 2017, from 17.82% in January 2017. The FPI was driven by higher prices of Bread and Cereals; Meat; Fish; Potatoes; yams and Other tubers; and wine. The Core Index increased by 16% in February 2017, lower than 17.90% recorded in January 2017.
In February 2017, the largest increase in the Core Index were recorded in the Electricity; Liquid and Solid Fuels; Fuels and Lubricants for Personal Transport; Clothing Materials; Other Articles of Clothing and Clothing Accessories and; Book and Stationeries.
Notwithstanding the fact that our analysis shows that inflation rate may continue to drop because of base effect; the decision of the Federal Government of Nigeria (FGN) regarding the pump price of Petroleum Motor Sprit (PMS) and the electricity tariff will ultimately determine the actual path that the inflation rate will follow in the short-term. We estimate that the inflation rate would be at 16.52% in March 2017 as shown on table 4 below. This may impact the yields on the fixed income securities.
1.5 Movement in the External Reserves:
There was accretion to the external reserves in March 2017, with a slowdown in the rate of growth towards the end of the month of March 2017. The improved production of oil in the Niger Delta, as well as the OPEC and non-OPEC actions on stabilising oil price boosted the external reserves. However, the CBN’s strategy to increase foreign exchange supply had negative impact on the external reserves in March 2017. The 30-day moving average external reserves increased by 2.19% to US$30.30bn as at end-March 2017, from US$29.65bn at end-February 2017. The average external reserves stood at US$30.16bn in March 2017, from US$28.96bn in February 2017.
1.6 Crude Oil Market and Bonny Light Price:
The cooperation of OPEC and non-OPEC members to cut oil output has kept average oil price at about US$50/b since December 2016. However, there has been downward pressure on oil prices from the increased production in the U.S. The current relatively high oil price is attractive for shale oil producers.
According to the data from Thomson Reuters, the Bonny Light oil price decreased by 2.73% to US$52.71/b as at end-March 2017, from end-February 2017. The average price of Bonny Light was US$52.20/b in March 2017, a decrease of 5.95% from the average price of US$55.50/b recorded in February 2017.
According to the U.S Energy Information Administration (EIA), the Brent crude oil price should average US$55/b in 2017 and US$57/b in 2018.
1.7 Foreign Exchange Rate:
The recent efforts of the CBN to increase the supply of foreign exchange in the interbank market have narrowed the gap between the official (inter-bank) and parallel market exchange rates. The CBN was able to increase the supply of foreign exchange in the interbank market because of accretion to external reserves. The increase in average oil price to about US$50/bbl and increase in crude oil production in Nigeria are the major drivers of the improvement in the external reserves.
Month-on-month, the parallel market appreciated by 13.42% to close at N395/US$ at end-March 2017 from N448/US$ at end-February 2017. The average exchange rate at the parallel market appreciated by 14.59% to stand at N434.78/US$ in March 2017, compared with N498.23/US$ in February 2017.
The inter-bank market rate depreciated in March 2017. As at end-March 2017, the value of the Naira closed at N306.35/US$ at the inter-bank market, a depreciation of 0.28% from N305.50/US$ at end-February 2017.
The agreement between OPEC and Non-OPEC members to cut oil supply has led to an increase in oil price at the international market. There is no guarantee that this increase will be sustained. If it is not and the crude oil price drops faster than growth in local crude oil production, Nigeria’s export earnings may drop. Such a development would impede the ability of the CBN to sustain the improved supply of foreign exchange.
2.0 Interest Rate and Yield Analysis
The yields in the fixed income market recorded mixed performance in March 2017 compared with February 2017. The major drivers of yields were:
· Drop in the inflation rate
· Drop of liquidity in the market because of foreign exchange supply
· The improved confidence in the economy.
The fixed income market analysis in March 2017 shows a net outflow of about N351bn, compared with a net outflow of about N198bn in February 2017. The major outflows in March 2017 were the Primary NTBs of about N699bn; CBN’s Foreign Exchange Sale of N368bn; Open Market Operations (OMO) and Repurchase Bills (REPO) of N134bn and the bond auction of about N160bn. Meanwhile, in February 2017, the major outflows were from the OMO and REPO of N605bn, Primary NTBs of about N505bn, CBN’s Foreign Exchange Sale of N202bn; and the bond auction of about N160bn. The major inflows in March 2017 were the matured NTBs of about N699bn, matured OMO and REPO Bills of N71bn, and the Federation Account Allocation Committee (FAAC) injection of about N240bn. In February 2017, matured OMO and REPO Bills of N533bn; matured NTBs of about N505bn, and the FAAC injection of about N195bn were the major inflows.
At the NTBs auction, average yields at the shortest dated tenor NTB dropped while the average yield on the longest dated NTB increased in the month of March 2017. The average 91-day NTB yield stood at 14.08% in March, down from 14.23% in February. The average 182-day NTB yield closed at 18.81%, same as in February. The average 364-day NTB yield closed at 22.81%, up from 22.69% in February 2017.
Meanwhile, the average 30-day NIBOR closed at 16.73% in March 2017, marginally down from 16.90% in February 2017. The average 90-day NIBOR increased to 20.47%, from 19.32% in the preceding month.
The yields on the FGN Bonds that we monitored closed marginally lower in March 2017 than in February 2017.
2.1 Revised Outlook Going Forward:
A total inflow of about N701bn should hit the money market from the various maturing government securities and FAAC in the month of April 2017. Our expected outflows from the various sources such as government securities and statutory withdrawals are estimated at N822.41bn, leading to a net outflow of about N121bn.
The expectation of lower inflation rate; relative stability in the foreign exchange market and the expected economic recovery should result in lower yields going forward. However, market liquidity may drop as market operators continue to provide liquidity to fund foreign exchange supplies. This may limit the extent to which interest rate will drop in the short-term.
· Investors should take advantage of the current yields on one year Treasury Bills. The NTBs remain attractive as it is higher than the inflation rate
· Investors should also maintain a balanced portfolio in other fixed income securities, particularly in bonds in order to minimise reinvestment risk.
The average prices on the FGN Eurobonds were higher in March 2017 than in February 2017. Consequently, the average yields on the bonds closed lower in the month of March, than in February 2017. The attractiveness of the prices on the FGN Euro bond compared with similar risk profiled bonds led to the decrease in the yields in March 2017.
The current yields on all the FGN Eurobonds are lower than their respective coupons.
Please click here to download the FSDH strategy report for the month of April 2017