Tuesday, April 09, 2019 11:45 AM / Coronation Research / Header Image Credit: FX Empire
There was a small amount of profit-taking in the T-bill market last week, but the overall sense is one of mission accomplished – for 2019 – when it comes to reductions in market interest rates, stabilising FX reserves and anchoring the Naira. Equities languish, pending a pick-up in economic growth.
The Central Bank of Nigeria’s (CBN) FX reserves currently stand at US$44.68bn. Since the beginning of the year US$7.75bn has been injected into the NAFEX market through Foreign Portfolio Investment (FPI) while the CBN’s contribution has been just US$1.42bn. We believe that the current reserve level is sufficient for the CBN to defend the Naira exchange rate through 2019.
Bonds & T-bills
The yield on a Federal Government of Nigeria (FGN) Naira bond with 10 years to maturity rose by 36bps to 14.71%, and at 3 years rose by 37bps to 14.34% last week. The yield on a 364-day T-bill rose by 3bps to 14.61%. The yield on a T-bill with 3 months to maturity increased by 107bps to 11.98%.
Following a significant inflow of foreign money into Nigeria’s fixed income markets which brought the 364-day T-bill yield down by 243bps during February and a further 44bps in March, there was a little profit-taking last week. The yields at one and at 10 years now are only 10bps apart. Given that we expect a low issuance level compared with recent months, we think the CBN will be content to see 364-day risk-free rates fall a little further, perhaps to a range of 13.80% to 14.30% (see Coronation Research: Monetary Policy Committee, Surprise cut to 13.50%, 26 March).
The price of Brent increased by 2.85% last week to US$70.34/bbl. The average price, year-to-date, is US$64.25/bbl, 10.38% lower than the average of US$71.69/bbl in 2018, but 17.35% higher than the US$54.75/bbl average seen in 2017.
Oil is currently trading above its five-month high and, in our opinion, may continue to rally on the basis of escalation of the conflict in Libya. The risk is of a shortfall in oil supply from Libya, adding to the current supply squeeze from Venezuela and Iran.
The Nigerian Stock Exchange (NSE) All-Share Index recorded a loss of 4.59% last week, taking the year-to-date return to negative 5.77%. Last week Sterling Bank (+8.33%), Cadbury Nigeria (+5.00%) and Stanbic IBTC (+0.54%) closed positive while UBA (-19.48%), CCNN (-14.57%) and Oando (-12.39%) fell. On Wednesday last week, shares of UBA became ineligible for its N0.60 final dividend, so week-on-week the adjusted decline stood at 11.68%.
Buying interest in the equity market is low as fixed income securities still remain the most attractive bet for foreign investors. However, if rates continue to fall and GDP growth picks up, this pattern could reverse.
Strong FPI, weaker rates, Strong Naira
In Coronation Research: Nigeria Weekly Update, 25 March, we highlighted the disruptive influence of US$10bn of FPI inflows in Q1 2019 on our forecast of market interest rates. Our base case, then, was for a fall in market rates in Q4 2019. Our most bullish projection was for rate compression to occur in Q3 2019.
However, strong appetite for emerging market bonds, both US dollar-denominated and local currency-denominated has changed the picture. We now expect one-year T-bill rates in the secondary market to trade between 250-300bps above inflation, which at present suggests a band of 13.80% - 14.30%.
Furthermore, activity in the T-bill and OMO markets are converging to average levels. The subscription rate at the 3 April auction for 364-day T-bills was 2.26x the amount offered. At the auction on 27 February it was 11.75x - the highest level of demand in more than 10 years. On average, T-bill auctions are oversubscribed 2.51x.
Because high subscription levels have been associated with steep interest rate cuts, the return to trend demand at recent auctions is indicative of more gentle changes in interest rates.
Moreover, a move to cut rates much below current levels might be counter-productive for exchange rate stability, in our view, provided benchmark rates in the US and other developed markets remain unchanged.
While we adjust our view on market interest rates, our exchange rate projection appears more robust than when we first published it on 15 Jan 2019. (See Coronation Research: Year Ahead 2019, A tale of two halves, 15 January). CBN reserves are up 3.63% this year and an upward swing of 31.6% in oil prices (Brent) year-to-date is positive for our FY 2019 forecast of NGN362.59/US$1.