February 16, 2021/Cordros Report

In our 2021 domestic macroeconomic outlook report, we highlighted that the CBN would adopt a combination of higher yields on OMO bills and further devaluation of the local currency to lure foreign portfolio investors back into Nigeria in a bid to solve the liquidity crunch in the foreign exchange market. Recent happenings in the OMO segment of the Treasury bills market and the FX market suggest this may come earlier than we expected. The recent actions from the monetary authority are necessitated by the need to reverse the trend of declining FPI inflows since Q1-20 and enable the country to benefit from the global hunt for yields, given the low-to-negative yields in advanced economies. In this report, we discuss the significance of the CBN’s actions as well as the implications on the FX, fixed income and equities markets.

Hike in OMO Rates: Will FPIs be Swayed? 

At the February 4, 2021 OMO primary auction, the CBN more than doubled the yields on instruments sold, increasing the average stop rate by 467bps to 8.5%. The stop rate of the longest dated instrument (362-day) closed at 10.1% (previous stop rate: 5.7%) – the highest level since the April 30, 2020 auction (12.6%). This occurred despite the auction being undersubscribed and the CBN allotting c.90% of the total amount offered on each tenor. Interestingly, there was limited participation from local banks due to the tight liquidity conditions arising from CRR debits and FX retail auctions during that week. This occurrence, whether coincidence or not, left the auction, and higher rates mostly to foreign investors.  Hence, we are of the view that the hike in stop rates was done majorly to ignite FPI interest which would support US dollar inflows. While we believe this is a necessary condition to attract FPIs, we think it is insufficient given (1) yields are still relatively lower than African peers, (2) FX liquidity is still thin despite the accretion in FX reserves, and (3) the CBN is still yet to communicate clear guidelines on its FX policies.

CBN Revised Rates for the Non-Deliverable Forwards

Data obtained from FMDQ shows that the rate on the one-year Non-Deliverable Forward (NDF) was adjusted by 2.7% to NGN452.82/USD (Previously: NGN440.86/USD) on the February 2, 2021. Accordingly, the CBN also revised the NDF terminating on February 24 to NGN412.14/USD (Previously: NGN405.13/USD), a premium of 4.3% over the IEW spot rate of NGN395.00/USD at the end of the same day. In our view, the rationale behind this is to (1) retain FPI flows given the size of NDF maturities over the year, and (2) attract new FPI flows to ease the pressures in the Balance of Payments (BoP).

Outlook on the Currency Market

Although the CBN’s recent hawkish actions are in contrast to the forward guidance provided at the January MPC meeting, we think it has come to terms with the fact that attracting portfolio investments is crucial in easing the liquidity constraints in the FX market. With the NDF rates being adjusted, it only makes sense for a proportionate adjustment in the spot rate for there to be a balance or convergence between the two rates. Although convergence does not necessarily need to happen, we still think it suggests that a devaluation is imminent and will come earlier than we expected.

Market Impact

Considering that the key issues that have kept foreign investors away for almost a year still linger on, the CBN will have to offer even higher yields to elicit FPI interest. In our view, the CBN will have to keep OMO rates at current levels, at least, to show strong intent, as there is a strong possibility that participants in the market, especially FPIs, will continue to make aggressive bids to test the apex bank’s resolve.

Furthermore, we expect demand for higher yields in the Treasury bonds secondary market, especially for longer-dated instruments, to intensify, considering the increased rates on short term instruments. Thus, at this week’s FGN bond auction, we expect aggressive bids from investors, as they seek higher premiums. Overall, we expect auction stop rates to close higher.

In the equities market, the bearish sentiments (ASI is down 4.3% from its 2021 peak) that have dominated market performance over the last eight trading sessions indicate domestic investors are increasingly worried about the changing dynamics in the yield environment. We expect dividends announcements that will accompany 2020FY earnings releases to support market performance in the short term. Notwithstanding, there is the possibility that increasing fixed income yields will temper demand for stocks, as investors scale down their positions in anticipation of higher yields in the FI market amidst the unimpressive macro story.

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