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Economy | Nigeria Economy

T-Bill Rates Heading Towards 10.0%

Mar 02, 2021   •   by   •   Source: Proshare   •   eye-icon 6056 views

Tuesday, March 02,2021 / 09:22 AM / by Coronation Research / Header ImageCredit: Getty Images



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Recent auctions in the Nigerian Treasury Bill (T-bill) market havereached yields of 5.5% (for 1-year paper), trending upwards and trading muchhigher than yields in the secondary market. We think that T-bill yields canreach 10.0% per annum, if not higher, by mid-year. There is also a complexconnection with rising US dollar bond yields.

 

FX

Lastweek the exchange rate in the Investors and Exporters Window (I&E Window)weakened by 0.17% to N410.48/US$1. In the parallel, or street, market the Nairadepreciated by 0.42% to close last week at N482.00/US$1. With the two rates17.4% apart we believe that the World Bank may continue to insist on theunification of Nigeria's exchange rates, despite changes made during the pastyear. On the other hand, the most recent exchange rate adjustment to theI&E Window rate (in February) was by 7.0%. So, in our view, a few more suchadjustments could easily close the gap between the NAFEX market and the I&EWindow on the one hand, and the cash parallel market on the other, if theCentral Bank of Nigeria (CBN) permits this.

 

Bonds & T-bills

Lastweek, the secondary market yield for an FGN Naira bond with 10 years tomaturity declined by 2bps to 10.77% and at 7-years declined by 12bps to 10.33%while at 3-years the yield declined by 110bps to 6.84%, making the yield curvesteeper (see page 2). What has happened is that longdated FGN bonds have beenselling off while maturities of 5-years and under are being bought. Theannualized yield on a 335-day T-bill remained unchanged at 2.07% in thesecondary market, while the yield on a 333-day open market operation (OMO) billof the CBN declined by 64bps to 8.96%. At last week's Primary Market Auctionfor T-bills, on the other hand, the stop rates closed higher by c.133bps onaverage across the three tenors, closing at 2.00%, 3.50%, and 5.50% for the91-, 182- and 364-day offers respectively. Although there is noticeablerotation in the bond market from long-dated to short-dated maturities, webelieve that the overall trend in rates is upwards and will remain so for atleast several weeks.

 

Oil

Theprice of Brent crude rose by 1.36% last week, closing at US$66.13/bbl, a 27.66%increase yearto-date. The average price to year-to-date is US$58.80/bbl, 26.49%higher than the average of US$43.22/bbl in 2020. The combination ofaccelerating vaccination drives, government stimuli, and continued supplydiscipline on the part of producers have lifted oil prices recently. It isnoticeable that among OPEC+ members (OPEC plus Russia) compliance withscheduled production cuts reached 103% in January, higher than the 101%recorded in December. However, OPEC+ is meeting this week to discuss itsagreement and expectations are that some members may push for moderateproduction increases. Press reports indicate that Saudi Arabia and Russia areonce again at odds over production policies, especially in the light of the oilprice rally so far this year and the return of US shale to internationalmarkets. We believe there is there exists potential for oil prices to moderateafter this meeting.

 

Equities

TheNigerian Stock Exchange All-Share Index (NSE-ASI) fell by 0.96% last week witha loss of 1.17% year-to-date. Oando (+12.38%), Guinness Nigeria (+4.54%), andStanbic IBTC (+3.36%) closed positive last week, while Nigerian Breweries(-11.86%), Honeywell Flour Mills (-9.77%) and Lafarge Africa (-7.60%) closednegative. Despite the effect of rising market interest rate yields, there's thelikelihood of investors taking positions in dividend-paying stocks as companieslike Zenith Bank and MTN Nigeria release their full-year 2020 corporateearnings. However, our overall sense is that interest in the market is weak.

 

T-Bill Rates Heading Towards 10.0%

Yieldsin the Nigerian Treasury Bill (T-bill) market are rising and last week wereceived several clues as to their future direction. In recent weeks tradinghas focused on the primary market auctions. Last week a T-bill with 364 days tomaturity was sold at 5.5%: two weeks prior that it had sold at 4.0%. If we arecorrect in thinking that the primary auctions accurately reflect supply anddemand (more so than the secondary market) then: a) it follows that investorsare pushing rates up; and b) it suggests that the Debt Management Office (DMO)and the Central Bank of Nigeria (CBN) tolerate these developments.

 

TheCBN issued open market operation (OMO) bills in February at just over 10.0% perannum (pa). These sales are only available to foreign investors and Nigerianbanks. OMO bill yields, therefore, do not translate into the secondary marketfor T-bills where pension funds, insurance companies, mutual funds and othersare active. However, as we argued on these pages two weeks ago, the CBN may besending a signal to all the fixed income markets with its OMO rates.

 

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Onesolid argument for allowing rates to rise is that Nigeria's T-bill yields areout of step with interest rates in other nations, which inhibits foreignportfolio investment (FPI) reaching Naira-denominated securities. Wheninternational investors look at local currency yields, they usually compareyields with local inflation, with a simple inflation adjustment (1-yr risk-freerate minus inflation) being a sufficient guide (which is often seen as a proxyfor upcoming devaluation). On this comparison Sub-Saharan African countrieslike Ghana and Kenya score well and so too, to some degree, does South Africa.Large nations like Brazil, Russia, India and China currently have 1-yearrisk-free rates close to inflation. Nigeria is a significant outlier.

 

Whenit comes to inflation, interest rates are a contributory factor. Other keyfactors include effective exchange rates; external input prices (notably theprice oil as reflected in petrol and diesel prices); structural factors (inother words, efficiency); money supply (including financing of government).Clearly, it is difficult for policy makers in any country to address all thesevariables at the same time. However, interest rates can be addressed quitestraightforwardly. And when headline inflation increases from 15.75% y/y inDecember to 16.47% in January, then the case for allowing market interest ratesto rise is easy to make.

 

Howdoes this square with what the CBN is saying? We are fortunate in that theGovernor of the CBN, Godwin Emefiele, made his opinions clear in an address tothe Vanguard Economic Summit last week (Thursday 16 February) organised by theVanguard Newspaper. He voiced his concerns that: "the economy stillremains on a fragile recovery path. It is therefore imperative that we do allwe can in 2021 to ensure that we build on the positive momentum and strengthenour efforts at stimulating growth." The answers to the question of how tokeep the economy growing include measures to: "Sustain the accommodativefiscal and monetary policy measures aimed at improving access to finance tohouseholds and businesses," and "Improving Foreign Exchange inflowsinto the country."

 

Do accommodative fiscal and monetary policy measures necessarilymean a continuation of 2020's policies of low interest rates? We do not thinkso. Accommodative fiscal policy can mean helping government to reach its budgettargets, which does not have a direct bearing on interest rates. Accommodativemonetary policy measures do not necessarily imply low interest rates, especiallywhen one considers that the CBN makes a priority of targeted lending tostrategic sectors such as agriculture in its efforts to support the economy.These can be considered accommodative measures, not just market interest rates.And allowing market interest rates to rise squares with the Governor's stateddesire to improve foreign exchange inflows.

 


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The US Bond Connection

It is not often that the US bond market appears to have aninfluence on Nigerian rates. They are usually quite separate. Yet we cannothelp noticing that US 10-year bond yields are rising just at the same time asNigerian Naira 1-yields are rising. (Note that we are talking about 1-yr Nairayields and 10-year US bond yields: short-term rates in the US are still trendingdownwards.) Is there a connection?

 

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The narrative behind the rise in US 10-year bond yields is asfollows: the US is introducing an enormous fiscal package to stimulate theeconomy; this implies that economic growth will pick up; some models link ratesdirectly to growth; in any case, growth could imply rising inflation in whichcase the US Federal Reserve system would be obliged to raise rates at somepoint in future. The narrative in Nigeria is somewhat different: inflation isalready rising even though growth is slow (the economy grew by 0.11% in Q42020); interest rates needs to rise if these will help contain inflation;attractive interest rates are needed for foreign investment.

 

So, the similarities between the two markets are not obvious. Onthe other hand, the rise in US 10-year government bond rates is having somesignificant effects: the advance in commodity prices has paused; the US Nasdaqmarket of technology stocks corrected by 6.9% in the second half of February;the yields of emerging market sovereign Eurobonds have begun to rise, after 10months of relentless yield compression. This year began with a the 'global huntfor US dollar yield' thesis intact: now it has a question mark over it. Forthe issuer and for the holders of Nigerian sovereign Eurobonds it is importantto consider the implications. We will return to this topic next week.

 

Model EquityPortfolio

Last week the Model Equity Portfolio fell by 0.03% compared with afall in the Nigerian Stock Exchange All-Share Index (NSE-ASI) of 0.96%,therefore outperforming it by 93 basis points. Year to date it has lost 0.73%against a loss in the NSEASI of 1.17%, outperforming it by 44bps.

 

Last week our notional positions in five bank stocks did well, witha combined contribution of 49bps. The notional position in Stanbic IBTC, whichcost us dear the week before (62bps) partly redeemed itself last week with acontribution of 13bps.

 

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Last week we forewarned our readers that we would make sales amongour industrial stocks in order to raise our notional cash position by up tofive percentage points, in the event making notional sales to bring thenotional cash position up from 13.2% to 17.0%. We made notional sales in MTNNigeria, Dangote Cement and Airtel Africa (which, frustratingly, is a veryilliquid stock at the moment). We intend to continue with these tactics thisweek with the aim of reaching a notional cash position of 20.0%.


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 Proshare Nigeria Pvt. Ltd.

Proshare Nigeria Pvt. Ltd.

 

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