Tuesday,September 15, 2020 / 12:17 PM / By Coronation Research / Header Image Credit: Ecographics

The past three weeks have seen an unusual number ofmacroeconomic changes. The Central Bank of Nigeria (CBN) announced plans toclear the backlog of foreign currency demands and began supplying US dollars tothe Bureaux de Change (BDC). Nigeria won an important High Court case inLondon. And oil prices fell. However, we don't believe that Nigeria's policymix (low interest rates combined with holding the currency) will change anytime soon.

FX

The Naira weakened against the US dollar last week inthe parallel market, closing at N455/US$1 from N440/US$1 a week earlier. Theeffect of sales of FX to Bureaux de Change (BDC) operators by the CBN appearsto be short-lived. Although the CBN determines the sales price for the USdollar to BDC operators and the margin they are allowed to sell, other factorsare at play, notably: the trade deficit, the backlog of US dollar demand andoil prices play. In the NAFEX market the Naira remained stable around N386/US$1.

Bonds & T-bills

Last week the secondary market yield for an FGN Nairabond with 10 years to maturity increased by 10 basis points (bps) to 9.00%, andat 3 years decreased by 163bps to 3.86%. The annualised yield on 356-day T-billdecreased by 53bps to 2.56% while the yield of a CBN Open Market Operation(OMO) bill with similar tenure decreased by 28bps to 2.91%. At the T-billauction last week, the Debt Management Office (DMO) offered bills worthN128.06bn (US$128.0m), across different maturities: N4.41bn of the 91-day;N14.00bn of the 182-day and N109.65bn of the 364-day T-bills. This week, weexpect market activities to be influenced by strong market liquidity as a totalof N658.40bn (US$1.73bn) is due to come into the system: N350bn from OMO maturitiesand N308.40bn from T-bill maturities.

Oil

The price of Brent crude decreased by 6.63% last weekto US$39.83/bbl. The average price, year-to-date, is US$42.60/bbl, 33.65% lowerthan the average of US$64.20/bbl in 2019. Last week, oil prices slipped belowUS$40/bbl for the first time since mid-June. The unprecedented decline iscoming barely a month after Organisation of Petroleum Exporting Countries(OPEC)  tapered production cuts from 9.7mbpd to 7.7mbpd, while it appearsthat global demand for oil is still weak and may not return to pre-COVID-19 erauntil the end of year.

Equities

The Nigerian Stock Exchange All-Share Index (NSE-ASI)declined by 0.05% last week. The year-to-date return is negative 4.66%. Lastweek Lafarge Africa (+6.67%), Oando (+6.67%), Stanbic IBTC (+5.26%), AccessBank (+4.65%) and PZ Cussons (+3.66%) closed positive, while Ardova Oil(-9.92%), Guinness Nigeria (-6.57%), GT Bank (-5.84%), Fidelity Bank (-5.38%)and International Breweries (-4.11%) closed negative.

The Policy Mix and TheMarkets

A few weeks ago the Central Bank of Nigeria (CBN)announced that it would sell US dollars to the country's Bureaux de Change(BDC). This looked like a generous move by the CBN, and the parallel marketduly reacted by taking its offer price for US dollars down from N477/US$1 toN435/US$1 in a matter of days (it has since move back up to N455/US$1).

At the same time the CBN announced that it wouldclear a backlog of demand in the foreign exchange markets, where individualsand companies bid for US dollars at around N389.6/US$1 in the NAFEX market(also know as the I&E Window, and the rate quoted by Bloomberg). Ourinterpretation of CBN policy is that it is attempting to unify the NAFEX andthe parallel rates by lowering the parallel rate (rather than by devaluing);and it is pacifying foreign portfolio investors in Nigeria.

Then two things happened, one good, one bad. As wewrote last week, the High Court in London granted Nigeria more time to prepareits case in its ongoing legal battle with the British Virgin Islands-registeredengineering company Process & Industrial Developments (P&ID). If thisjudgement holds then it could mark a change in fortunes for the FederalGovernment of Nigeria in its battle over this approximately US$10.0bn claim.

And oil prices fell. The price of Brent, which hadbeen trending in a narrow range between US$40.00/bbl and US$46.0/bbl, fell fromUS$45.28/bbl at the end of August to US$39.83/bbl last Friday. We must rememberthat this is only a short-term move (likely due to tapering of OPEC productioncuts) and could be reversed. However, it makes the prospect of oil prices overUS$50.00/bbl appear more remote than before. Our long-held view is thatNigeria's public finances work best when oil prices are above US$50.00/bbl.

Does this herald a change in the policy mix? We doubt it. Neither of the CBN's recent initiatives point to a change inforeign exchange policy: in fact they reinforce it. The drop in oil pricesmight disappoint the CBN but it does not change its strategy. It wants lowmarket interest rates to stimulate the economy (which also lowers the cost ofissuing FGN T-bills and bonds). And it wants to hold the currency where it is.

Model Equity Portfolio

Last week the Model Equity Portfolio declined by0.22%, compared with a fall in the Nigerian Stock Exchange All-Share Index(NSE-ASI) of 0.05%, therefore underperforming it by 17 basis points.Year-to-date it has lost 0.18%, against a loss of 4.66% in the NSE-ASI,outperforming it by 447bps.

Our underperformance was caused by our increasednotional holdings of bank stocks (19.4% of the portfolio). We increased ourholdings last month to position the portfolio for potential upside when theirH1 2020 results are released. While we were aware that the results may be farfrom impressive because of reduced business activities during the period, wethought a selected few will report some good numbers and declare dividend.

Although this was the case, the stocks sold offrather quickly as investors took profits. We are not worried about the bankingstocks as we think the stocks may rally as it approaches ex-dividend date.

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