09, 2019 02:25PM / CardinalStone Research / Header Image Credit: CardinalStone Research
Global Economy – Monetary authorities tilt to dovish orientation
As expected, Outlook remained at the heart of global economic discourse and could well prove to be the most influential force in determining global growth for 2019E. Only recently, the IMF slashed its global growth expectation by 10bps to 3.2% YoY partly due to concerns around the US-China trade tensions and its likely pass-through to other economies. Elsewhere, the dark cloud around Brexit and geopolitical tensions remained key considerations for global growth outlook. Unsurprisingly, GDP releases so far this year, together with generally softening inflation, point to weaker-than-anticipated global activity. Investment and demand for consumer durables have been subdued across advanced and emerging market economies as firms and households continue to hold back on long-range spending. On this wise, the ubiquitous gravitation to monetary policy accommodation in developed and emerging market economies looks set to subsist until the end of the year. However, we note that the near-term risk to global growth remain firmly to the downside. According to the International Monetary Fund (IMF), these risks include: 1. intensification of trade and technological tensions 2. protracted increase in risk aversion that exposes the financial vulnerabilities and 3. rising disinflationary pressures that increase debt service difficulties, constrain monetary policy space to counter downturns, and make adverse shocks more persistent than normal.
Nigeria – Should currency stability remain the priority?
In Nigeria, monetary policy direction remains largely unclear, with the monetary authorities leaving all its policy parameters unchanged in its late July meeting on the one hand, while implementing pro-growth administrative policies such as the increase in loan to deposit ratio requirement and reduction of the maximum amount banks can place on the Standing Deposit Facility (SDF) on the other. We believe the decision on the handling of currency remains the most crucial going forward. The Central Bank of Nigeria (CBN), through its monetary policy committee, appears to have re-affirmed a willingness to continue its “currency protectionism”, mostly by drawing down on reserves to offset occasional shocks when necessary. Unfortunately, this strategy has failed to attract the needed patient capital into the country in the last five years mostly due to CBN’s stronghold on currency. For context, volatile foreign portfolio flows into Open market operation (OMO) bills now constitute c.27.0% of Nigeria’s reserves, according to IMF. Clearly, interest rate spreads over key benchmarks will be the key motivator for this class of investors to roll over their investments in OMO bills.
Markets – Currency regime shakeup could be the key
Despite attractive valuations, a reversal of fortunes for equities is likely to depend on a decisive policy tweak to the currency regime. Since 2017, investors have priced in a forward premium over spot rates in the naira forward market (currently 1Y forward priced at ₦400.0/$), indicating expectations of imminent naira devaluation. Until this dark cloud is erased, we see little or no legroom for significant equity market correction in the near-term.