Tuesday, October 27, 2020   /07:50 PM / by CoronationResearch/ Header Image Credit: Khan Academy

What willbe the fiscal and monetary responses to the events of the last week? Themonetary authorities are probably relieved that the equity market advanced lastweek; that there was a rally in the bond market; and that the exchange ratebarely moved. There is no evidence that financial markets were alarmed. In mostcountries, the fiscal and monetary authorities would consider a fiscal stimulusand monetary easing.  

FX  

Last weekthe foreign exchange rate held essentially flat, with the Naira appreciating by0.06% against the US dollar to N385.71/US$1 in the NAFEX market (also known asthe I&E Window). In the parallel, or street market, the Naira depreciatedby 0.22% to close at an offer price of N463/US$1. The two rates are stillwithin 20% of each other. We expect continued pressure on the parallel exchangerate going forward but do not think that it will move much, given the policy ofthe Central Bank of Nigeria (CBN) to supply US dollars to the Bureaux de Change(BDC).  

Bonds & T-bills  

Lastweek, the secondary market yield for an FGN Naira bond with 10 years to maturitydecreased by 107 basis points (bps) to 4.17%, and at 7 years fell by 102bps to4.00%, while at 3 years the yield declined by 20bps to 3.18%. The annualisedyield on 328-day T-bill fell by 122bps to 0.77% while the yield on a OMO billwith similar tenure fell by 209bps to 0.78%. Following the contraction inyields witnessed last week, we expect demand for instruments in the T-billssecondary market to slow down over the coming week. We expect investors' focusto be on the primary market auction (PMA) holding next week, in which the CBNwill roll over NGN160.3 billion (US$414.5m) worth of maturing bills. However,we do not expect a sharp rise in market interest rates.  

Oil  

The priceof Brent crude dropped by 2.70% last week to US$41.77/bbl. The average price,year-to-date, is US$42.50/bbl, 33.79% lower than the average of US$64.20/bbl in2019. Demand for crude around the world has slowed due to the surge in Covid-19cases especially for countries in Europe, Latin America and the USA. The surgehas helped explain the weakening in demand for gasoline in affected countries.But, on the bright side, demand for aviation fuel is rising in Asia. We thinkthat the pandemic will continue to keep the price in a narrow range of betweenUS$40/bbl and US$46/bbl. over the coming weeks.  

Equities 

TheNigerian Stock Exchange All-Share Index (NSE-ASI) rose by 0.13% last week, witha gain of 6.91% year-to-date. Losses early in the week were reversed as aresult of bargain hunting in the last two trading sessions of the week, pushingthe market into the black. Last week, International Breweries (+18.20%), FlourMills (+6.24%) and Nigerian Breweries (+5.69%) closed positive, while CadburyNigeria (-6.83%), Honeywell Flour Mills of Nigeria(-6.19%) and Guinness Nigeria(-5.34%) closed down.  

The Policy Response to Events 

TheDomestic Outlook  

How willNigeria's fiscal and monetary authorities react to the events of the past week?We believe that their concerns will focus on business continuity, in otherwords figuring out how quickly businesses can return to normal and what can bedone to help. There are many practical aspects to this, such as the loss of POSmachines from retailers, damage to property, and the impact on insurers. Allthese will be assessed. The next step is to formulate policies.  

In termsof monetary policy, the Central Bank of Nigeria (CBN) already has a pro-growthstance which encourages commercial banks to lend to businesses (for example,through the mandatory 65% loan-to-deposit ratio) and it has seen marketinterest rates fall to record lows this year. A back-to-business policy wouldbe consistent with its existing stance, requiring no change in direction. It couldsignal its desire for further expansion through its Monetary Policy Rate (MPR)which it recently cut, on 22 September, from 12.50% to 11.50%. It could alsointroduce measures to further encourage banks to lend and to increase overallsystem-wide liquidity, though it might wish to maintain the current cashreserve rate (CRR) at 27.5%. It could also expand its own targeted lendinginitiatives. In short, we expect the CBN to be busy.  

Like theCBN, the Federal Government of Nigeria (FGN) already has a pro-growth stancewith its N2.3 trillion (US$5.9bn) Nigerian Economic Sustainability Plan so,again, no change in policy direction is required. As we often point out,government in Nigeria is not large in relation to GDP, so the ability ofgovernment to stimulate the economy is much less than in developed economies.However, this does not rule out an initiative on this front. One key point isthe stability of Nigerian financial markets. The equity market rallied a littlelast week, the bond market continued its rally, and the exchange rate hardlymoved. The Nigerian Stock Exchange Insurance Index fell last week, but only by0.6%. From the point of view of US dollar investors, yields on FGN Eurobondsmoved very little last week. In fact, they were affected more by the contagionfrom Zambia and Angola in late September than they were last week.  

Thisshows that financial markets believe in a swift return to business as normal,something which, in our opinion, takes the pressure off policy makers in theshort term. Rather than having to support financial markets, as sometimeshappens in developed nations, Nigeria's policy makers can afford a hands-offapproach to them. And they can focus directly on the issues of businesscontinuity and the flow of credit.  

TheInternational Outlook  

In timeslike these it is possible to focus too much on domestic conditions and not payenough attention to the international outlook. This would be mistake becausesignificant changes may be afoot. The US presidential election takes place on 3November and if the Democratic Party candidate, Joe Biden, is elected thenthere would be knock-on effects on global oil markets. Biden supports a nucleardeal with Iran, which could result in certain sanctions being lifted and anincrease in Iranian oil sales to global markets. This could hold the price ofoil down, delaying its much-forecast return to over US$50.00/bbl in 2021. 

Conversely,a Biden administration would likely take a more positive attitude to engagingwith African nations than the present incumbent, presenting Nigeria with freshopportunities.  

At thesame time, the surge of liquidity directed by central banks in developedmarkets to combat the effects of the Covid-19 pandemic is likely to havesignificant effects on emerging markets. Global investors are, one again,hungry for yield and are likely to renew their search again in 2021. Thisaugurs well for Federal Government of Nigeria (FGN) should its Debt ManagementOffice opt for a Eurobond issue next year. Nigeria was absent from the Eurobondmarket in 2019, is unlikely to issue during the closing months of 2020, andtherefore might be welcome if it choses to issue in 2021.  

Asinternational investors search for yield in 2021 it may even be possible toresume, at some point, issues Naira-denominated fixed-income securities tointernational investors, thereby restarting significant levels of ForeignPortfolio Investment (FPI). International factors hold many of the keys forpolicy makers going into 2021. 

Model Equity Portfolio 

Last weekthe Model Equity Portfolio fell by 0.07% compared with rise in the NigerianStock Exchange All-Share Index (NSEASI) of 0.13%, therefore underperforming itby 20 basis points. Year-to-date it has gained 13.36% against a gain of 6.91%in the NSE-ASI, outperforming it by 645bps.  

Ourunderperformance is attributable to our notional positions in banks, notablyZenith Bank, though we note that our notional positions in GT Bank and StanbicIBTC both made positive contributions.  

Ouroverall notional position in banks is 29.2%, compared with a index-neutralposition of close to 20.0%, and this overweight was largely responsible for ourthree straight weeks of outperformance against the NSE-ASI prior to last week.We continue to think that banks offer interesting dividend yields in thecontext of falling yields in the bond markets and we are minded to maintain ournotional overweight position. 

In fact,with a strong rally in the bond market and further OMO bill redemptions due inDecember, it seems to us that Nigerian institutional investors may continue todiversify their holdings and therefore may continue to buy equities. Althoughwe try to make overall calls on the direction of the market as infrequently aspossible, the reappearance of institutional investors recently persuades usthat the equity market is likely to remain supported going forward. We plan noportfolio changes for the coming week. 

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