Before last week’s FOMC meeting

Financial markets across the globe, particularly the emerging market counterparts were thrown off-balance between June and mid-September after the U.S Fed signalled in its FOMC meeting that it will scale back on the US$85 billion monthly bond purchases contingent upon positive economic data.

Following the announcement, there was bloodbath in emerging markets that sent stock prices and currencies to record low levels. Reuters estimated that between April and September, US$86 billion left Asia, half of the outflows having been from China. MSCI emerging market index fell by 7.45% from the end of May to early September.

The Nigerian market was not isolated from the wave of global capital reversal. From a YtD high of 42.5% in June, return on equities market fell to 29% on September 13th while yield on FGN bonds equally rose to an average of 13.6% as prices could no longer withstand the sell pressures.

Clues from the U.S FOMC meeting

The press release from the September FOMC meeting indicates a slight deterioration of the Fed’s perception of the macroeconomic environment. It also noted that improvement in the labour market has been very cautious while the tightening of financial conditions represents a growing risk for the prospects of recovery, notably for the real estate market.

Consequently, the committee’s growth projection for 2013 was revised downwards to 2%-2.3% from 2.3%-2.6% in June and also lowered the prediction for next year to 2.9%-3.1% from 3% and 3.5% previously.

Hence contrary to all expectations, the Federal Reserve kept its policy of US$85 billion asset purchases unchanged, resulting in a marked rise in stock market and a flattening of the yield curve.

QE Extension – A temporary relief

Markets across the globe went agog by the auspicious pronouncement by the U.S Federal Reserve. Commodity prices spiked hours after the decision was made public while the U.S and emerging market stocks equally assumed upward trends. The move provoked Wall Street to hit record highs, with the Dow rising 1.11%, the S&P 500 gaining 1.4% while Nasdaq added 1.1%. The MSCI emerging market index swung 3.6% following the announcement and rose to June levels after four days.

The Nigerian All Share Index appreciated in two straight sessions after five days of consecutive declines that preceded the fed meeting. Also, from 13.62% on September 17th yields on FGN bonds contracted to 13.39% three days after.

How soothing is the relief? The Nigerian case

The local bourse seems to have fallen back to a quiet mood after the short rally. The bull and bear have had equal share of this week’s four trading sessions, leaving investors with a net return of -0.08%. Average volume of trades still stands at the mid-200 million levels, unchanged from the pre-relief period. There are no indications yet that the gains witnessed so far were driven by the activities of foreign fund managers. Hence we attribute the upside to local players’ cautious positioning in anticipation of the “would be” FPIs inflows.

The fixed income market on the contrary appears to be the preferred destination as price rallies have seen average bond yields contract consistently from 13.64% as at September 16th to 13.07% on Wednesday this week.

The Nigerian September MPC meeting

The committee:

§     Maintained status on policy measures from July.

§     Expressed satisfaction with the prevailing macroeconomic stability experienced quarter-to-date.

§     Acknowledged that the persistent domestic foreign exchange demand pressure is rather political and not import driven.

§     Stated that the temporary postponement of the US QE tapering portends uncertainties in external conditions for Nigeria.

§     Expressed concern about the worsening condition of the oil sector.

§     Noted that six-month inflation outlook indicates that the index would remain within single-digit.

§     Acknowledged that the U.S QE tapering extension and improved outlook for financial stability in Europe reduces the risk of local currency instability.

More eyes on the Naira

The CBN reiterated its commitment to defending the naira. In addition to the measures it had deployed so far, the apex bank noted at the meeting that it is working on new policies and regulations aimed at combating money laundering (a major pressure point for the naira) at the BDC segment. In this light, the apex bank has indicated plans to revoke the licences of 20 Bureau De Change operators, suspend the current Wholesale Dutch Auction System (WDAS) and re-introduce the Retail Dutch Auction System (RDAS) effective October 3rd, 2013.

This assurance holds positive implication for the Nigerian market given that a stable exchange rate is a focal consideration for foreigners seeking investment in emerging markets.

Outlook and conclusion

The stability of the Nigerian exchange rate is an important selling point for the local market. In addition, a single digit inflation outlook is an attraction for positive real return on investment. With the equities market cheaply valued relative to first half of the year, we believe the domestic market will be a destination to consider as FPIs begin their “yield hunt”. At 13.10%, average yield on FGN bond is equally attractive relative to the sub-12% level it moderated to in March.

However the Fed’s caveat that the QE tapering is unavoidable poses downside risk to our outlook. FPIs’ exposures to emerging markets will be highly conservative bearing in mind that the QE extension is not cast on stones.

The mixed expectations around Q3 results will likely keep market momentum under check till October ending. The CRR effect on banks cannot be overestimated and any lag in Q3 performance may impact adversely on market sentiment.

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Source: Investment One