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Market | Bonds & Fixed Income

Nigerian Fixed Income Remains a Tough Sell

Oct 05, 2021   •   by   •   Source: Proshare   •   eye-icon 1386 views

Tuesday, October 05,2021 / 11:06 AM / by Coronation Research / Header ImageCredit:  Ecographics 

 

Lastweek, we discussed the performance of the equities market and stated that it istime to give Nigerian stocks another look. Today, we look at the trends in thefixed income market and expand on why we think fixed income will remain not aneasy sell unless under the heading 'You have nowhere else to go'.


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FX

Last week, the exchange rate at the Investors and Exporters Window(I&E Window) appreciated by 0.37% to N413.38/US$1. Elsewhere, the CentralBank of Nigeria's FX reserves rose by 1.35% WTD to US$36.60bn (29 September2021) - the highest level since 12 February 2020 - signifying the sixthconsecutive weekly accretion. In our view, the reserves partially reflect theInternational Monetary Fund's (IMF) Special Drawing Rights (SDR) allocation to Nigeria.In addition, the FGN also successfully raised US$4.00bn in Eurobonds lastmonth. This will be banked with the CBN and should see the reserves rise toabove US$40.00bn over the next few weeks, enough to provide the apex bank withenough ammunition to defend the Naira in the short term. Nevertheless, FXturnover on the official markers remains relatively low. Thus, there may becontinued pressure on the official and parallel exchange rates if the CBN doesnot increase supply.

 

Bonds & T-bills    

Last week, sentiments in the Federal Government of Nigeria (FGN)bond market were mixed with a bullish tilt, as demand at the top of the week,following much-improved system liquidity, offset the primary auctionresult-induced selloffs. Consequently, the average benchmark yield for bondsfell by 3bps w/w to close at 11.20%. The yield of an FGN Naira-denominated bondwith 10-years to maturity was flat at 12.02%. However, the yield on the 7-yearbond fell by 5bps to 11.55%, and the yield on the 3-year bond fell by 32bps to8.83%. We reiterate our view that a future rise in bond yields, if any, isunlikely to be sharp over the coming months due to unaggressive borrowing asthe DMO manages its debt service costs.

 

Trading in the Treasury Bill (T-Bill) secondary market was bullishas inflows from the monthly federal disbursements to states and localgovernments (c.N360bn) and OMO maturities boosted system liquidity. As aresult, the average benchmark yield for T-bills fell by 32bps w/w to 5.29%,with demand concentrated at the mid-segment of the curve. Elsewhere, theaverage yield for OMO bills declined by 11bps in the week to close at 6.32%.Specifically, the annualised yield on a 343-day T-bill fell by 81bps to 7.49%,while the yield on a 320-day OMO bill rose 12bps to 7.53%. At the T-billprimary market auction (PMA), the DMO allotted N115.01 billion (US$279.84m)worth of bills across all tenors. Accordingly, stop rates remained unchanged onthe 91-day (2.50%) and the 181-day (3.50%) bills, while the rate on the 364-daybill rose by 30bps to 7.50% (8.11% annualised yield). Notably, demand at theauction was relatively weak, with a total subscription of N174.74bn - thelowest level since April 2021 - and a bid-to-offer ratio of 1.56x (vs anaverage of 4.30x over the last six months).


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Oil

The price of Brent crude rose by 1.52% last week to close at aUS$79.28/bbl. Year-to-date, Brent is up 53.05% and has traded at an averageprice of US$68.05/bbl, 57.46% higher than the average of US$43.22/bbl in 2020.The price rallied - and almost hit US$80.00/bbl - amidst supply concerns aroundHurricane Ida's disruptions and some Organization of the Petroleum ExportingCountries (OPEC) members inability to significantly increase production as oildemand picks up with the easing of pandemic restrictions across the globe.However, production in the Gulf returning close to levels reached before thehurricane and power crisis and housing market concerns in China put a ceilingon the oil price. Today, OPEC+ are scheduled to meet as the group facespressure from some countries to produce more to help lower prices since demandhas recovered faster than expected in certain parts of the world. Nonetheless,we reiterate our view that the price of Brent oil is likely to remain wellabove the US$60.00/bbl mark for several months.

 

Equities

The NGX All-Share Index (NGX-ASI) surged by 3.23% last week, thelargest weekly gain since the week has ended 29 January 2021, to close at40,221.17 points. Notably, the index crossed the 40,000 psychological mark tohit its highest level since 24 February 2021, almost erasing all its losses forthe year (YTD: -0.12%). Dangote Cement +14.29%, Presco +9.93%, FBNH +7.33% andNestle Nigeria +5.71% closed positive last week, while BUA Cement -2.94%, FCMBGroup -2.36%, Guinness Nigeria -1.33% and Honeywell Flour Mills -1.05% closednegative. Sectoral performances were bullish as the NGX Industrial led thegainers, rising by +6.65%, followed by NGX Consumer Goods +3.35%, NGX Oil &Gas +0.92% and NGX Banking +0.60% indices. Conversely, the NGX Insurance indexdeclined by -7.58%.

 

Nigerian fixed Income Remains a Tough Sell

This year, the theme for the fixed income markets has been spreadwidening, with the average yield of FGN bonds expanding by 508bps YTD and theaverage yield on Treasury Bills (T-bills) expanding 482bps YTD. Yields on theCBN's OMO bills have also followed a similar trajectory, rising by 581bps YTD.The widening was much more significant in the middle of Q2 2021. However,yields reversed from that point on.


 

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Overall, the widening came as investors continued to demand higheryields at auctions amidst surging inflation. Other factors that influencedyields include the squeeze in system liquidity (see Coronation Research, Interest rates and banks'margins), reducing participationfrom institutional investors (who preferred higher-yielding fixed deposits),and the federal government's significant deficit financing needs this year.

 

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Where do we go from here? On the demand side, N1.59trn [T-bills(N610.30bn), OMO bills(N750.90bn) and FGN coupon payments (N224.91bn)] worth ofinstruments will mature and contribute to system liquidity in Q4-21.Additionally, as monthly contributions grow, demand from Pension FundAdministrators (PFA) is likely to remain strong. PFAs have approx. N13trn inassets under management with about N7.65trn (64% of AUM) invested in governmentsecurities.

 

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On the supply side, we highlight that the federal governmentplanned to raise a total of N2.34trn in domestic debt to fund its budgetdeficit for 2021. As of end-Q3 2021, the government has raised 102% of itstarget for the year and is not likely to be under significant pressure to increaseits local debt stock over the rest of the year.

 

In our view, yields seem to have hit the ceiling or resistance atcurrent levels. If any, a future rise in yields is unlikely to be sharp overthe rest of the year. With the monetary authorities still mainly concerned withdriving growth, it seems clear that they have finished with the effectivetightening of market interest rates that characterised the first half of theyear. Thus, for the time being, they seem content to see 1-year yieldssubstantially below 10.0% and average bond yields below 12%.


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