In line with market expectations, the Governing Council of the European Central Bank (ECB) voted to increase the three key policy rates by 75bps – the main refinancing rate at 1.25%, the marginal lending facility at 1.50% and the marginal deposit facility at 0.75%. According to the Council, the primary reasons for the hike were; (1) inflation remains far too high and is likely to stay above target for an extended period and (2) the labour market remained robust – the unemployment rate settled at a historic low of 6.6% in July. Moreover, based on its current assessments, the Governing Council expects to raise interest rates further to dampen demand and guard against the risk of a persistent upward shift in inflation expectations. Given that consumer prices remain elevated and are likely to stay above the ECB’s target over the short-to-medium term, we align with the Governing Council that further rate hikes would be needed to keep inflation expectations low. Indeed, the current market expectation is for the ECB to raise the key policy rates further by 50bps at its next policy meeting on 27 October.

According to the National Bureau of Statistics (NBS) of China, the Chinese headline inflation eased by 20bps to 2.5% y/y in August, from a 2-year high of 2.7% y/y recorded in July. We understand that the moderation in consumer prices reflects (1) weak domestic consumer demand given restrictive COVID-19 measures in line with the government’s zero-COVID strategy and (2) a slowdown in global crude oil prices. Accordingly, inflationary pressures eased across the food (6.1% y/y vs July: 6.3% y/y) and non-food (1.7% y/y vs July: 1.9% y/y) baskets. Notably, we highlight that the moderation in transport (-120bps to 4.9% y/y) and housing (-10bps to 0.6% y/y) costs partly drove the slowdown in non-food inflation. On a month-on-month basis, headline inflation declined by 0.1% (July: +0.5% m/m). We believe inflationary pressures are on course to ease further in the months ahead, given the lingering strict COVID curbs and its associated impact on demand. Notwithstanding, we highlight that the recent severe heatwave in several regions of the country could be a headwind to food prices in the near term. 

Global Markets

This week, global stocks were broadly positive as investors digested hawkish remarks from policymakers that cemented bets of further rate hikes amid price pressures. Accordingly, US (DJIA: +1.5% and S&P 500: +2.1%) stocks were on track to close positively. Similarly, European equities (STOXX Europe: +0.4% and FTSE 100: +0.7%) advanced as investors digested a slew of central bank news. Asian markets posted positive performances, as the Nikkei 225 (+2.0%) posted a weekly gain, taking a cue from the rally on Wall Street. Likewise, the SSE (+2.4%) closed positively as a slower-than-expected inflation reading supported bets for more monetary stimulus. Elsewhere, the Emerging (MSCI EM: -1.5%) and Frontier (MSCI FM: -0.6%) markets stocks settled lower following losses in South Korea (-1.0%) and Kuwait (-1.3%), respectively.

Nigeria

Economy

According to the National Bureau of Statistics (NBS), VAT collection maintained its increase, rising by 17.2% y/y to NGN600.15 billion in Q2-22 (Q2-21: NGN512.25 billion | Q1-22: NGN588.60 billion). The increased VAT collections reflect the impact of (1) higher prices of goods and services and (2) resilient consumer spending. Accordingly, the growth in local (+91.6% y/y to NGN359.12 billion | 59.8% of total VAT collection) and NCS-import (+10.9% y/y to NGN129.90 billion | 21.6% of total VAT collection) VAT collections were enough to offset the decline in foreign VAT collections (-46.5% y/y to NGN111.13 billion | 18.5% of total VAT collection). Finally, we highlight that VAT collections increased by 2.0% on a quarter-on-quarter basis. In the absence of any major shock to the domestic economy, we expect the lingering recovery in domestic demand to remain supportive of VAT collections even as inflationary pressures remain elevated. Accordingly, we expect the combined impact of higher VAT and CIT collections to support the FGN’s non-oil revenue in 2022E.

Nigeria’s trade balance maintained a surplus position for the second consecutive month as exports rose faster than imports. According to the recently released trade report by the National Bureau of Statistics (NBS), the trade balance surplus settled at NGN1.97 trillion in Q2-22 (+502.3% y/y vs Q2-21: NGN327.35 billion). The trade surplus was due to a faster increase in total exports (+47.5% y/y to NGN7.41 trillion) given elevated crude oil prices (+63.3% y/y to USD112.81/bbl.) even as crude oil production remained underwhelming. Elsewhere, total imports rose by 15.8% y/y to NGN5.44 trillion (Q2-21: NGN4.69 trillion | Q1-22: NGN5.90 trillion) on account of the (1) resilient domestic demand, (2) higher freight costs, and (3) elevated global commodity prices exacerbated by Russia/Ukraine conflict. Although we expect the higher crude oil prices to support exports over the short term, we expect the impact to be tethered by low crude oil production volume. Similarly, we believe the higher global commodity prices relative to the prior year would continue to exert upward pressures on total imports amid pressure on the local currency. Accordingly, we expect the trade balance surplus to moderate over the short term.

Capital Markets

Equities

The bears resurfaced on the domestic bourse as the benchmark index recorded declines in three of the five trading sessions. Accordingly, the All-Share index dipped by 0.7% w/w to close at 49,695.12 points. Particularly, profit-taking activities witnessed in ZENITHBANK (-5.3%), STANBIC (-4.6%), AIRTELAFRI (-2.0%), and FBNH (-1.4%) drove the weekly loss. Consequently, the MTD and YTD returns settled at -0.3% and +16.3%, respectively. Activity levels were weak, as trading volume and value declined by 20.5% w/w and 27.8% w/w, respectively. Finally, sectoral performance was mixed as the Insurance (+1.0%), and Consumer Goods (+0.7%) indices advanced, while the Banking (-0.6%) and Oil & Gas (-0.1%) indices declined; the Industrial Goods index closed flat.

We expect alpha-seeking investors to rotate their portfolios towards cyclical stocks that delivered decent earnings during the Q2-22 earnings season amid the yield uptick in the FI market. However, we think the absence of a near-term catalyst will likely skew overall market sentiments to the negative side, particularly as the political space gets heated. Notwithstanding, we reiterate the need for positioning in only fundamentally sound stocks as the unimpressive macro environment remains a significant headwind for corporate earnings.

Money market and fixed income

Money market

This week, the overnight (OVN) rate closed lower by 350bps, w/w, at 9.0%, as the system remained saturated with liquidity from the prior week despite the absence of significant inflows. We highlight that the average system liquidity level settled lower this week, but remained positive at a net long position of NGN78.72 billion (vs a net long position of NGN352.31 billion in the previous week).

We expect the OVN rate to trend northward next week, as the thin inflow from OMO maturities (NGN35.00 billion) may not be sufficient to keep system liquidity afloat.

Treasury bills

The Treasury bills secondary market sustained its bullish sentiments driven by the (1) ample liquidity in the market and (2) market participants looking to the secondary market to fill lost bids at the week’s NTB PMA. As a result, the average yield across all instruments contracted by 9bps to 8.4%. Across the segments, the average yields contracted by 31bps and 1bp to 10.8% and 7.7% at the OMO and NTB secondary markets, respectively. At the NTB PMA, the CBN offered NGN214.74 billion – NGN20.77 billion of the 91-day, NGN31.29 billion of the 182-day, and NGN162.68 billion of the 364-day – in bills. Eventually, the CBN allotted precisely what was offered at respective stop rates of 5.50% (previously 4.00%), 5.85% (previously 5.00%), and 10.00% (previously 8.50%).

In the coming week, we expect yields in the T-bills secondary market to expand from current levels, given our expectations of tight liquidity conditions. Also, we anticipate quiet trading at the NTB segment as participants position for next week’s PMA, with NGN159.60 billion worth of maturities on offer.

Bonds

Elsewhere, activities in the Treasury bonds secondary market turned bearish this week, driven by investors’ sell-offs of positions at the short and mid spectrum of the curve. Consequently, the average yield inched higher by 18bps to 13.0%. Across the benchmark curve, the average yield expanded at the short (+56bps), mid (+4bps) and long (+7bps) segments as investors sold off the APR-2023 (+293bps), FEB-2028 (+19bps) and MAR-2035 (+52bps) bonds, respectively. Notably, the DMO revised the Q3-22 FGN bond issuance calendar, reflecting that the DMO has replaced the 13.00% FGN JAN-2042 bond with the 16.25% FGN APR-2037 bond. 

We maintain our view of an uptick in bond 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 dipped after three consecutive weeks of accretion, falling by USD81.74 million w/w to USD38.92 billion (as of 6 September). Across the FX windows, the naira depreciated by 1.1% to NGN436.33/USD and NGN708.00/USD at the I&E window and parallel market, respectively. At the IEW, total turnover (as of 8 September) declined by 62.2% WTD to USD282.85 million, with trades consummated within the NGN425.00 – NGN437.50/USD band. In the Forwards market, the naira depreciated at the 1-month (-0.3% to NGN435.83/USD) contract, but appreciated at the 6-months (+0.1% to NGN452.19/USD) and 1-year (+0.3% to NGN476.36/USD) contracts. Conversely the naira was flat at the 3-months (NGN440.30/USD) contract.

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 that 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.