According to the Office for National Statistics (ONS), headline inflation in the UK rose to a 40-year high, increasing by 30bps in June to 9.4% y/y (May: 9.1% y/y). The persistent increase in inflationary pressures reflects the lingering impact of the (1) soaring energy prices, (2) post-pandemic supply chain disruptions, and (3) passthrough effect of the Russia-Ukraine conflict. Notably, the cost of motor fuels (42.3% y/y vs May: 32.8% y/y) is at its highest on record, while food prices (9.8% y/y vs May: 8.6% y/y) rose to their highest rate since March 2009. Other notable significant price pressures include housing & utilities (19.6% y/y vs May: 19.4% y/y) and transportation (15.2% y/y vs May: 14.0% y/y). On a month-on-month basis, consumer prices rose by 0.8% (May: 0.7% m/m). Inflationary pressures are still biased to the upside in the near term, with the Bank of England expecting inflation to peak slightly above 11.0% in October. The preceding suggests that the BoE could be pressured to keep increasing the key policy rate even as it continues to plod at a slower pace than the US Fed.

Against its previous guidance of a 25bps hike, the Governing Council of the European Central Bank (ECB) voted to raise the three key policy rates by 50bps and approved the Transmission Protection Instrument (TPI) at its recently concluded July policy meeting. The increase marks the first-rate hike in 11 years and the biggest since 2000. According to the Council, the TPI will be an addition to its toolkit and can be activated to counter unwarranted, disorderly market dynamics that pose a severe threat to the transmission of monetary policy across the Euro Area. Overall, the Council judged that further interest rate normalisation would be appropriate at its upcoming meetings even as its future policy rate path will continue to be data-dependent. Given that the hike is coming at a time the regional bloc is facing a severe stagflation shock, we are sceptical of further aggressive hikes into the year as we think the window for continuous rate hikes is closing amidst recession risks. Indeed, the Council recognised that its frontloading at the concluded meeting allows it to make a transition to a meeting-by-meeting approach to interest rate decisions.

Global Markets

Despite the broader narrative around major central banks tightening and the resulting headwinds to global economic growth, global stocks rallied this week as investors’ appetite for risk assets improved following (1) impressive corporate earnings releases, and (2) the Chinese central bank’s pledge to support China’s economy. Accordingly, US (DJIA; +2.4% and S&P 500; +3.5%) stocks were set for a weekly gain, buoyed by the rally in tech stocks after better-than-expected earnings releases, particularly from Tesla and Netflix, earlier in the week. European (STOXX Europe: +2.6% and FTSE 100: +1.7%) stocks were also on course for a positive close as investors assessed inflation data and corporate earnings while evaluating the path of monetary policy. Likewise, Asian markets (Nikkei 225: +4.2%; SSE +1.3%) posted positive performances following the rally on Wall Street and investors’ positive reaction to China’s banking regulator’s pledge to take measures to stem the property crisis and mortgage boycott. In the same vein, the Emerging (MSCI EM: +3.0%) and Frontier (MSCI FM: +0.8%) markets mirrored the bullish trend across global stocks consequent upon gains in China (+1.3%) and Kuwait (+4.7%), respectively.

Nigeria

Economy

The Monetary Policy Committee (MPC) of the Central Bank of Nigeria (CBN) unanimously voted to increase the Monetary Policy Rate (MPR) by 100bps to 14.0% – the second consecutive rate hike and the highest level in 42 months. The hike brings the total rate increase so far in 2022 to 250bps, representing the largest annual increase since 2011FY (+575bps). The Committee also voted to retain the asymmetric corridor around the MPR at +100bps/-700bps, Cash Reserve Requirement (CRR) at 27.5%, and Liquidity ratio at 30.0%. Although the Committee agreed with our sentiments that the last hike had not permeated considerably in the economy, we believe the decision to hike must have been induced by the (1) unabating inflationary pressures and (2) need to move ahead of the US fed which is expected to increase its key policy rate by 75bps at its next meeting on 27 July – to ensure that the impact on the domestic economy would be limited. Overall, we envisage that the MPC would raise the MPR by an additional 50bps further into the year if global central banks march on with aggressive rate hikes and domestic inflationary pressures persist.

According to the recently released data by the Budget Office, the FGN’s aggregate revenue (including GOEs) settled at NGN1.63 trillion in 4M-22 – 50.9% below the pro-rated budget (NGN3.23 trillion). We are unsurprised by the gross underperformance, given that we had expected oil revenue to drag overall revenue performance due to (1) low crude oil production volume and (2) elevated subsidy cost. Indeed, oil revenue (NGN285.38 billion vs pro-rated budget: NGN730.12 billion) only recorded 39.1% performance during the revenue period. Elsewhere, non-oil and other revenue under-performed their pro-rated budgets by 16.0% and 62.5%, respectively. Meanwhile, although aggregate expenditure (NGN4.72 trillion vs pro-rated budget: NGN5.77 trillion) underperformed by 18.3%, we highlight that debt service (NGN1.94 trillion) was well ahead of the pro-rated budget by 47.0%. Consequently, the fiscal deficit printed NGN3.09 trillion. At this run rate, the fiscal deficit would settle at NGN9.27 trillion in 2022E, which is c. 5.0% shy of our base case expectation (NGN9.74 trillion) as highlighted in our H2-22 domestic macroeconomic outlook. Accordingly, we envisage increased domestic borrowing and reliance on the CBN’s Ways & Means (W&M) as external borrowing conditions are presently unfavourable. Indeed, the actual W&M in 6M-22 was NGN2.45 trillion, according to the CBN.

Capital markets

Equities

The bears resurfaced in the local bourse this week as the All-Share Index dipped by 0.5% w/w to close at 51,979.92 points. Notably, profit-taking activities witnessed in NB (-10.9%), INTBREW (-6.9%), WAPCO (-6.7%), and ZENITHBANK (-6.5%) stocks led the weekly loss. Consequently, the MTD and YTD returns moderated to +0.3% and +21.7%, respectively. However, activity levels were upbeat, as trading volume and value increased by 81.9% w/w and 96.9% w/w, respectively. Analysing by sectors, the Banking (-4.1%), Consumer Goods (-2.0%), and Industrial Goods (-0.5%) indices declined, while the Oil and Gas (+3.8%) and Insurance (+1.8%) indices advanced.      
   
In the interim, we believe the full swing of the H1-22 earnings season will dictate market sentiments and possibly drive positive performance as investors hunt for bargains in fundamentally sound stocks with a consistent history of interim dividend payments. Notwithstanding, we envisage intense selling pressures on stocks of companies that grossly underperform in H1-22. Overall, 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

The overnight (OVN) rate expanded by 100bps w/w to 15.0%, as the already strained system liquidity was further pressured by debits for FGN bond (NGN123.85 billion) and FX auctions amid inflows from FGN bond coupon payments (NGN181.96 billion) and OMO maturities (NGN10.00 billion).

In the coming week, we expect system liquidity to remain tight as the expected inflows worth a combined NGN81.01 billion from FGN bond coupon payment (NGN51.01 billion) and OMO maturities (NGN30.00 billion) may not be sufficient to saturate the system and outweigh next week’s outflows.

Treasury bills

The Treasury bills secondary market sustained last week’s bearish sentiments following the unhealthy liquidity in the system. As a result, the average yield across all instruments expanded by 66bps to 7.7%. Across the segments, the average yield increased by 158bps and 35bps to 8.9% and 7.3% at the OMO and NTB secondary markets, respectively.

Following the lower inflows expected in the system next week, we expect a low demand for T-bills and a slight expansion in yields from current levels. Also, we expect market focus to be shifted to the NTB PMA holding on Wednesday (27 July), with the CBN expected to roll over NGN264.28 billion worth of instruments.

Bonds

The bears continued to dominate the Treasury bonds secondary market as the average yield across instruments expanded by 38bps to 11.9%. We attribute this week’s bearish sentiment to investors re-pricing bonds in reaction to the MPC’s rate hike on Tuesday. Across the benchmark curve, the short (+89bps), mid (+9bps), and long (+14bps) instruments bore the impact of the sell-offs as investors took profits off the MAR-2024 (-184bps), NOV-2029 (+37bps), and APR-2049 (+38bps) bonds, respectively. At this month’s bond PMA, the DMO offered instruments worth NGN225.00 billion to investors through re-openings of the 13.53% MAR 2025 bond (Bid-to-offer: 0.2x; Stop rate: 11.0%), 12.50% APR 2032 (Bid-to-offer: 0.3x; Stop rate: 13.0%) and 13.00% JAN 2042 (Bid-to-offer: 1.4x; Stop rate: 13.75%) bonds. Demand was relatively low, with a subscription level of NGN142.29 billion, translating to a bid-to-offer ratio of 0.6x (vs bid-to-offer: 2.5x in the previous auction). The DMO eventually allotted instruments worth NGN123.84 billion, resulting in a bid-to-cover ratio of 1.2x.

We maintain our view of an uptick in bond yields in the medium term, as both the FGN’s borrowing plan for 2022FY and expected fiscal deficit point towards an elevated supply.

Foreign Exchange

Nigeria’s FX reserve recorded another accretion this week, rising by USD10.91 million w/w to USD39.44 billion (18 Jul 2022). Across the FX windows, the naira appreciated by 0.1% to NGN430.00/USD at the I&E window (IEW) but depreciated by 0.3% to NGN622.00/USD at the parallel market. At the I&E window, total turnover (as of 21 Jul 2022) increased by 278.7% WTD to USD803.75 million, with trades consummated within the NGN410.00 – 444.00/USD band. In the Forwards market, the rate was flat at the 1-month (NGN427.40/USD) contract, but depreciated at the 3-month (-0.1% to NGN435.50/USD) contract. The rate appreciated at the 6-Month (+0.3% to NGN448.09/USD) and 1-year (+0.2% to NGN471.71/USD) contracts.

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.