6/7/2018/Proshare Research 

In the wake of 2016, the Federal government in attempt to reflate the economy due to liquidity concerns coupled with hard pegs hinged deeply on the domestic money market by focusing primarily on short term instruments to fund the budget. The cost of financing the budget was high on the back of rising inflation and a hawkish monetary policy. Thus, the fiscal authorities found themselves absorbing huge debts at relatively high cost, making debt servicing a smoking elephant. Expected, the expected short rates have shifted from “rising to falling” on the back of dwindling inflation.

Source: CBN

Liquidity premium have tilted from constant to rising, as forward rate take a lift – which is reflective in the OMO bills. 

An humped yield curve gradually give way as a more inverse one take hold. Therefore the dynamic between a positive real rate and lower inflation premium, allows a lower discounted cash flow to be applied on federal government long term instrument. However, with the normalization of interest rate abroad, expected rise on long rate on foreign interest have begun to rise as the effective annual rates have risen too.  Underlying the new reality that the cost of external borrowing will rise while the cost of domestic debt dampen as inflation fall. 

Therefore a mildly bearish position has taken hold, even though we foresee an increase in the supply of long and medium term securities by the fiscal authorities to fund the N 9.12 trillion budget.

We also expect monetary authorities to revert back to dynamic sterilization in attempt to alter supply as the election season takes steam with the intent of influencing rates both at the interbank and exchange rate corridor.

Table 1:  Treasury bill

Source: CBN

 Therefore, the rates are largely steep as inflation premium begin to trigger falling expected rate, while pinpointing to a more constant liquidity premium, compared to the past where liquidity premium increased. 

Fig 2: Correlation between tenor and yield (Treasury bills)

Source: Proshare research  

Table2 : Open Market Operation (OMO)

Source:  CBN

Fig 3: Correlation between tenor and yield (OMO) 

Source: Proshare research

• On the other hand, OMO bills have risen steeply, as liquidity largely increases with maturity
• We expect supply of more OMO bills by the apex bank, as the election draws nearer in order to clamp down excess supply of the nominal currency.    

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