CBN Likely to Leave MPR at 11.50%

TuesdayNovember 24, 2020 / 12:08 PM / by Coronation Research / Header ImageCredit: Premium Times

The Monetary Policy Council (MPC) of the Central Bankof Nigeria (CBN) meets today and is due to deliver its verdict on its MonetaryPolicy Rate (MPR) tomorrow. We think that, after its surprising cut from 12.50%to 11.50% in September, it will leave the MPR on hold now. The CBN is happywith low market interest rates and can even argue these contributed to themildness of the Q3 GDP print (negative 3.62%, year-on-year). It could evenconsider a further cut but, despite seeing little connection between interestrates and inflation, is probably chastened by the recent rise to 14.23%.

The CBN last week reversed its ruling on the use ofthird parties to access foreign exchange for imports. The result was quicklyfelt in the NAFEX market (also known as the I&E Window) where turnoverclimbed to US$205.8m (N79.4bn) on Thursday, a level not seen since August and,before that, March. The Naira appreciated by 0.03% in the NAFEX market toN385.50/US$1. However, and probably due to the build-up of stocks ahead of thefestive season, the Naira depreciated by 2.98% in the parallel market toN484/US$1. We think that there will be continued pressure on this rate over thecoming weeks.

Bonds & T-bills

Last week, the secondary market yield for an FGN Nairabond with 10 years to maturity dropped by 31 basis point (bps) to 4.39% from4.70%, and at 7 years also dropped by 5 bps to 4.10% from 4.15%, while at 3years the yield dropped by 7 bps to 1.82% from 1.89%. The annualized yield on343-day T-bill rose by 3 bps to 0.18% from 0.15%, while the yield on a 340- dayOMO bill dropped by 9 bps to 0.19% from 0.28%. During the week it was reportedthat, intra-day, some T-bill maturities were priced with negative yields.Overall, we sense that liquidity will continue to be high in the fixed incomemarkets as we go into December, as a high level of open market operation (OMO)bills are due to be redeemed during the month. Therefore, there is a realpossibility that bond rates will reduce still further and that negative Tbillrates could be reported at market close. We note that the OMO redemptionschedule for January is much lighter than in December, so the pressure may easeoff next year.

Oil

The price of Brent crude rose by 5.10% last week toUS$44.96/bbl. The average price, year-todate, is US$42.43/bbl, 34% lower thanthe average of US$64.12/bbl in 2019. This increase can be attributed to thedrop (by 9.5 million barrels) in the global storage level week-on-week to reach112 mbbl. Interestingly, the current floating storage volumes are 100 mbbllower than the June peak. We think oil will be supported around US$45.00/bbl,though it may be a while before it breaks decisively above US$50.00/bbl.

Equities

The Nigerian Stock Exchange All-Share Index (NSE-ASI)fell by -2.57% last week, with a gain of 27.18% year-to-date. Last week, BUA(+2.79%), Airtel Africa (+2.06%) and Lafarge Africa (+1.66%) closed positive whileOando (-19.75%), FBN Holdings (-12.12%) and Sterling Bank (- 11.42%) closednegative.

CBN Likely to Leave MPRat 11.50%

Last week Naira fixed income rates fell to new lowsand the one-year Treasury Bill yield rose only slightly after significant declinesin recent months. The mechanics of these interest rate moves arewell-understood. In October 2019 most Nigerian institutions and companies werebarred from bidding for new CBN open market operation (OMO) bills - a market ofN14.2 trillion (US$36.8bn) at the time. As their OMO bills matured this yearthey have had little alternative but to buy Federal Government of Nigeria (FGN)bills and bonds - the FGN T-bill market was worth just N2.4 trillion a yearago. Money flowed from the large market into the smaller one and yields shrank.

How will this factor affect the CBN Monetary PolicyCouncil's decision on the headline Monetary Policy Rate (MPR) which is duetomorrow, Tuesday 24 November? The MPC cut the MPR from 12.50% to 11.50% at itslast meeting in September. That cut signaled its approval of low marketinterest rates and its preference for stimulating economic growth over managinginflation (October: 14.23% y/y). In fact, the MPC communique stated that itsees structural factors (such as poor infrastructure) as causing inflation,less so monetary policy.

Proshare Nigeria Pvt. Ltd.

And the CBN can argue that its policy is successful.Credit to the private sector is sharply up this year and the FGN has been ableto finance its deficit at low interest rates. GDP was down 3.62% year-on-yearin Q3, but this is much better that the negative 6.10% y/y print for Q2, andimplies full-year performance better than the IMF's estimate of negative 4.30%development for 2020.

Nigeria now resembles certain developed markets, suchas the US, Japan and the EU, where short-term interest rates are either verylow or negative. In the US the 1-year T-bill yield is 0.10% (inflation: 1.2%),in Japan it is -0.16% (inflation: -0.4%) and in the Eurozone the interbank rateis -0.48% (inflation -0.3%). However, Nigeria is not a developed market. Mostmarkets outside the developed world have interest rates above inflation. In thetable we show one-year risk-free rates minus inflation for the BRIC countries(Brazil, Russia, India and China) and selected African markets. Some marketshave interest rates much lower than inflation, but they are not as extreme asNigeria.

Nevertheless, we still expect Nigeria to pursue thisunorthodox policy for a while, if only because its pro-growth strategy is(arguably) working. To this end, we believe the MPC will keep its 11.50% MPRrate. Though it could be tempted to further signal its intention to keep rateslow with a further rate cut (a token 0.50% cut in the MPR, for example), webelieve that the recent rise in inflation (from 13.71% y/y in September to14.23% in October) will temper its enthusiasm.

Model Equity Portfolio

These are tense times in the Model Equity Portfoliodepartment. We contend with a volatile market. Two weeks ago the market rose12.97% and last week it fell by 2.57%. Every day we see stocks moving wildly,often stocks that we seldom look at. There prompt fears that we are missing outon the action (earlier we did, in Flour Mills of Nigeria and Dangote Sugar,alas). And we see the value of stocks in which we have notional positions, likeFBN Holdings, fall by 12.1% in a week.

So, it is a relief to find that the Model EquityPortfolio outperformed last week. Last week the Model Equity Portfolio fell by2.06% compared with a fall in the Nigerian Stock Exchange All-Share Index(NSE-ASI) of 2.57%, therefore outperforming it by 51 basis points. Year-to-dateit has gained 32.90% against a gain of 27.18% in the NSE-ASI, outperforming itby 572bps.

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Our outperformance last week was caused by remarkablefalls in several bank stocks (e.g. FCMB Group, Fidelity Bank and Sterling Bank)and one oil company (Oando) in which we do not have notional positions. Thesefour stocks have small index weights but the quantum of their stock price moveshad a negative effect on the index.

Flour Mills of Nigeria and Dangote Sugar, two stocksin which, arguably, we should have had positions over the past three months(they did well) also fell heavily last week. This means that there may beopportunities to take notional positions in them when we complete our researchand if we become comfortable with their fundamentals and valuations. We lookfor a sustainable RoE above 20.5% and long-term sales growth above the rate of inflation(see Coronation Research, Navigating the Capital Markets: the Investor'sDilemma, 14 July 2020).

As was the case two weeks ago, we were grateful forour neutral notional positions in large index-neutral stocks, notably AirtelAfrica and BUA Cement, which both rose. We plan no changes in the Model EquityPortfolio this week.