August 14, 2018/InvestmentOne Report

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·         It would appear the most likely direction for yields on Naira denominated fixed income instruments may be north. Our view is premised on the continuous bearish sentiment towards emerging markets by foreign investors as the trade tensions between U.S. and China lingers as well as the projection for further rate hikes by the U.S. Fed in the second half of 2018.  

·         However, if we do see a change in foreign investor sentiment to emerging and frontier markets, we believe increasing political risk, as we move closer to the 2019 elections, may deter inflows into Naira denominated securities in the near term.  

·         With this said, we could see increased demand for Nigeria’s Eurobonds, especially if oil prices strengthen. 

·         Nonetheless, the potential for an expansion in yields in the domestic fixed income space is further supported by our outlook for inflation to accelerate in H2 2018.

·         Inflationary pressures as a result of election spending as well as higher government revenues (FAAC) could see CBN tighten its monetary policy by increasing the frequency of its OMO auctions to drain liquidity, which could pressure yields upwards. 

·         Also, if non-oil revenues continue to lag behind projections, as  widely expected given the unrealistic targets set in the 2018 budget, in our opinion, we could see the nation’s budget deficit widen further, which could lead to increased borrowings. In the absence of higher foreign borrowings, higher bond issuances domestically could also see yields in the secondary trend upwards.

·         Although the recent narrative has tilted towards a reduction in foreign investor interest towards the Nigerian fixed income market, we highlight that the possible re-inclusion into the JP Morgan Government Bond Index-Emerging Markets (GBI-EM) in the near future may result in a resurgence of foreign investor participation.

·         Nigeria was removed from the index in 2015 over concerns of deficiencies in the liquidity and transparency of the nation’s foreign currency market, which hindered the ability for foreign investors to repatriate funds. In our opinion, the decision markedly discouraged capital inflows to the fixed income market and contributed to significant outflows in 2015. Buoyed by higher oil receipts, a market driven foreign currency window (IEFX), a re-instatement into the index could be on the horizon.

·         We opine that such an event is made more likely as Nigeria has made noteworthy strides in the resolution of its illiquidity issues, with IEFX turnover amounting to a cumulative US$54billion since its establishment and foreign currency reserves inching up to US$47.79billion as at June 2018.

·         However, concerns remain on the credibility of CBN’s foreign currency policy in the face of significant shocks to the nation’s oil & gas sector.