The United States (US) consumer prices counter the narrative that inflation may be peaking, with prices rising higher than market expectations (8.8% y/y) for the second consecutive month. According to the Bureau of Labor Statistics (BLS), the US headline inflation increased by 50bps to 9.1% y/y in May (May: 8.6% y/y) – the highest print since November 1981. The lingering inflationary pressures primarily reflect the impact of (1) strong consumer demand, (2) elevated food and energy prices worsened by the Russia-Ukraine conflict, and (3) clogged supply chains exacerbated by China’s zero-COVID policy. Consequently, pressures remain significant in the prices of energy (41.6% y/y vs May: 34.6% y/y), food (10.4% y/y vs May: 10.1% y/y) and shelter (5.6% y/y vs May: 5.5% y/y). We expect the inflationary pressures to remain elevated in the short to medium term, given the nature of factors limiting supply amid higher consumer demand. Accordingly, we believe the Fed would maintain its rate hike to allow demand to match the supply conditions better. Indeed, the market expects the FOMC to raise the key policy rate further by 75bps (and a possibility of a 100bps hike) at its next meeting on 27 July.

According to the National Bureau of Statistics (NBS) of China, China’s economic growth weakened to the lowest level since the COVID-19-induced contraction in Q1-20. Specifically, real GDP grew by 0.4% y/y in Q2-22 (Q1-22: +4.8% y/y and Q2-21: +7.9% y/y). The soft pace of expansion primarily reflects the (1) widespread COVID-19 containment measures given the government’s zero-COVID strategy and (2) lingering real estate struggle amidst the government’s clampdown on property transactions. On a quarter-on-quarter basis, the world’s second-largest economy shrank by 2.6% (Q1-22: +1.4% q/q), given the disruption to consumer spending and the passthrough impact of supply chain constraints. Looking ahead, we expect the heightened geopolitical risks arising from the Russia-Ukraine conflict to weigh on China’s growth as supply and commodity cost pressures intensify. Moreover, intermittent COVID-19 infections and global monetary policy tightening also pose further downside risks to the near-term growth outlook. Accordingly, we do not expect the government to meet its annual growth target of 5.5% in 2022E. Indeed, the IMF expects China’s growth to decelerate to 4.4% in 2022E compared with 8.1% y/y growth in 2021FY. 

Global Markets

Risk-off sentiments reverberated across global equities as investors gauged the outlook for Federal Reserve interest-rate hikes and the resilience of China’s economy following the release of the latest (1) US inflation data and (2) readings on China’s economy. Accordingly, US (DJIA; -2.3% and S&P 500; -2.8%) stocks were on track for a weekly loss as investors digested disappointing quarterly results from two big US banks and hotter-than-expected inflation data. Likewise, European (STOXX Europe: -1.9% and FTSE 100: -1.6%) stocks were on course to close lower as investors continued to digest the latest US CPI print. On the other hand, Asian markets posted mixed performances as the SSE (-3.8%) recorded huge losses following the lower-than-expected China GDP report, amid the mounting distress in China’s housing market. Meanwhile, the Japanese (Nikkei 225; +1.0%) posted a weekly gain as the weakening in the yen against the greenback drove bargain hunting in export-oriented shares. Elsewhere, Emerging (MSCI EM: -3.4%) and Frontier (MSCI FM: -1.1%) markets mirrored the downbeat mood across global stocks consequent upon losses in China (-3.8%) and Kuwait (-0.5%), respectively.

Nigeria

Economy

According to the recently released data by the National Bureau of Statistics (NBS), headline inflation rose by 89bps to 18.60% y/y in June – the highest print since January 2017 (18.72% y/y). The outturn is in line with Cordros’ estimate (18.61% y/y) and 10bps higher than Bloomberg’s median consensus estimate (18.50% y/y). The increased consumer prices synchronised neatly with the impact of (1) high food demand-supply gap as planting season was underway, (2) PMS shortages, (3) elevated diesel and gas prices, and (4) lingering currency pressures, amid the unfavourable base effects from the prior year. Accordingly, we highlight broad-based pressures across the food and core baskets. While food inflation (+110bps to 20.60% y/y) increased to an 11-month high, we highlight that the core inflation (+85bps to 15.75% y/y) is at its highest level since February 2017 (16.01% y/y). We expect the consumer prices to maintain uptrend in July on account of (1) increased food demand in line with the Eid-El-Kabir celebration, (2) PMS shortages, (3) elevated energy prices, and (4) lingering currency pressures. Consequently, we forecast the headline inflation to settle at 1.84% m/m in July, with the corresponding base from the prior year translating to a 107bps increase in the y/y inflation rate to 19.66%.

The FGN’s fiscal deficit ran ahead of the pro-rate budgeted in February amid a persistent shortfall in the FGN’s retained revenue. According to the CBN’s monthly economic report, the FGN’s retained revenue declined by 8.4% m/m to NGN371.67 billion in February (January: NGN405.51 billion), primarily driven by lower inflow from the Federation account (-54.7% m/m) given the lower net oil and gas revenue. Simultaneously, aggregate expenditure increased slightly by 0.2% m/m to NGN952.61 billion (January: NGN951.14 billion) on account of higher recurrent (+22.7% m/m) spending amidst a slowdown in capital expenditure (-50.0% m/m). Consequently, the fiscal deficit (NGN580.93 billion vs pro-rated budget: NGN466.80 billion) rose by 6.5% m/m compared to January (NGN545.63 billion). We maintain our expectation of underwhelming FGN’s retained revenue in 2022E, given the expected significant shortfall in oil revenue. At the same time, we expect the government to meet its expenditure targets in line with historical precedence amid increased spending on vulnerable groups. Overall, our baseline expectation is that the fiscal deficit will print NGN9.74 trillion (including GOEs) in 2022E (2021E: NGN7.71 trillion).

Capital markets

Equities

Despite the shortened trading week due to the public holidays on Monday and Tuesday, the domestic bourse halted its bearish streak as AIRTELAFRI (+10.0%) closing limit up in today’s (Friday) session buoyed the market’s performance. Pertinently, the All-Share Index rose by 1.3% w/w to close at 52,215.12 points. Consequently, the MTD and YTD returns printed +0.8% and +22.2%, respectively. However, activity levels were weaker than the prior week, as trading volume and value declined by 38.7% w/w and 27.5% w/w, respectively. Across our sectoral coverage, the Industrial Goods (-3.4%), Insurance (-1.9%), Banking (-0.5%), and Consumer Goods (-0.3%) indices declined, while the Oil and Gas index closed flat.

We expect investors to trade cautiously in the week ahead as they anticipate the H1-22 earnings season. Notwithstanding, we reiterate the need for positioning in only fundamentally sound stocks as the weak macro environment remains a significant headwind for corporate earnings.

Money market and fixed income

Money market

This week, the overnight (OVN) rate was flat at 14.0% as the funding conditions in the system remained tepid, averaging this week with a net short position of NGN79.73 billion (vs a net short position of NGN127.41 billion in the previous week).

We expect the OVN rate to moderate slightly in the coming week, as a combined NGN191.86 billion – FGN bond coupon payments (NGN181.86 billion) and OMO maturities (NGN10.00 billion) – is expected to hit the system.

Treasury bills

Just as we envisaged, the tepid liquidity in the system this week underpinned another bearish performance in the Treasury bills secondary market as participants sold off instruments in both market segments to generate funds. Thus, the average yield across all instruments expanded by 32bps to 7.0%. Across the segments, the average yield increased by 105bps and 9bps to 7.4% and 6.9% at the OMO and NTB segments, respectively. At Wednesday’s NTB auction, the CBN offered NGN143.27 billion – NGN4.51 billion of the 91-day, NGN1.46 billion of the 182-day, and NGN137.30 billion of the 364-day – in bills. The auction closed with the CBN allotting precisely what was offered at respective stop rates of 2.75% (previously 2.40%), 4.00% (previously 3.79%), and 7.00% (previously 6.07%).

Next week, we expect improved demand for T-bills on the back of (1) expected inflows to the system and (2) participants’ reaction to the increased yields of bills in the market.

Bonds

Proceedings at the Treasury bonds secondary market turned bearish this week as demand weakened following investors’ positioning ahead of next week’s bond auction. Consequently, the average yield across instruments expanded by 19bps to close at 11.5%. Across the benchmark curve, the average yield expanded at the short (+31bps), mid (+41bps), and long (+4bps) ends as investors sold off the MAR-2024 (+89bps), JUL-2030 (+54bps), and JAN-2042 (+20bps) bonds, respectively.

In the coming week, we expect the outcome of the July 2022 FGN auction holding on Monday (18 July) to shape the direction of yields in the bonds secondary market. At the auction, the DMO will offer instruments worth NGN240.00 billion through re-openings of the 13.53% FGN MAR 2025, 12.5000% FGN APR 2032 and 13.0000% FGN JAN 2042 bonds. Nonetheless, we reiterate our stance of an uptick in yields in the medium term as the FGN’s borrowing plan for 2022FY and expected fiscal deficit point towards an elevated supply.

Foreign Exchange

Nigeria’s FX reserves sustained its accretion, as it grew by USD75.44 million w/w to USD39.43 billion (14 July 2022). Across the FX windows, the naira depreciated by 1.0% and 0.2% to NGN430.33/USD and NGN618.00/USD at the I&E window (IEW) and parallel market, respectively. At the I&E window, total turnover (as of 14 July 2022) decreased by 73.2% WTD to USD149.07 million, with trades consummated within the NGN411.42 – NGN444.00/USD band. In the Forwards market, the rate was flat at the 1-month (NGN427.37/USD) contract, but weakened at the 6-month (-0.1% to NGN449.55/USD) and 1-year (-0.2% to NGN472.81/USD) contracts. The rate appreciated at the 3-year (+0.1% to NGN435.17/USD).

Although the CBN has enough liquidity to support the FX market over the short term, we highlight that foreign inflows are paramount for sustained FX liquidity over the medium term. Considering the tepid accretion to the reserves given the (1) low crude oil production level and (2) elevated PMS under-recovery costs, FPIs which have historically supported supply levels in the IEW will be needed to sustain FX liquidity levels in the medium to long term. Hence, we think (1) further adjustments in the NGN/USD peg closer to its fair value and (2) flexibility in the exchange rate would be significant in attracting foreign inflows back to the market.