According to the flash estimates from S&P Global, the United States (US) Composite PMI remained below the 50-point psychological threshold for the third consecutive month, settling at 49.5 points in September (August: 44.6 points). Analysing the breakdown, we highlight that factory activity, as measured by the Manufacturing PMI, rose by 0.50 points to 52.0 points (August: 51.5 points), supported by renewed expansion in output and new orders on account of increased client demand. Elsewhere, the Services PMI settled higher at 49.3 points (August: 43.7 points) on account of (1) improved demand conditions and (2) reduced cost pressures which eased for the fourth consecutive month. In the short term, we expect private sector activity to continue to paint a broad picture of an economy struggling to regain momentum. Importantly, we expect the growth to be hampered by tightening financial conditions, weak external demand, and increased cost pressures.

Factory activity in the United Kingdom (UK) maintained its downturn for the third consecutive month as manufacturers again cut back production. According to the S&P Global/CIPS, the UK’s Manufacturing PMI settled at 48.4 points in September (August: 47.3 points), primarily driven by the (1) lingering cost of living crisis, (2) rising uncertainties, and (3) lower external demand. At the same time, the service sector recorded its weakest performance since February 2021 as the Service PMI slowed for the third consecutive month to 50.0 points (August: 50.9 points) on account of discretionary spending being hit by the persistent inflationary pressures amid widespread optimism about the economic outlook. Overall, the Composite PMI weakened further to 49.1 points (August: 49.6 points) – its lowest print since January 2021 (41.2 points). Over the short-to-medium term, we align with S&P Global that the overall economic performance is likely to remain in the doldrums given (1) increases in borrowing rates, (2) cost of living pressures, and (3) deepening uncertainties about the economic outlook.

Global Markets

Global stocks staged an impressive comeback from last week’s rout on the premise that global monetary policymakers may be eyeing a shift toward less aggressive tightening. However, sentiments turned bearish later in the week following the release of the U.S. payroll report (for September), which reignited fears of a more hawkish Fed. Accordingly, U.S. (DJIA: +4.2% and S&P 500: +4.4%) stocks rallied, supported by weak U.S. manufacturing data amid a short reprieve in rising U.S Treasury yields earlier in the week. Similarly, European equities (STOXX Europe: +2.1% and FTSE 100: +1.5%) were on course for a solid start to the month as investors flocked into cyclical stocks despite the weak eurozone PMI data. In Asian markets, the Nikkei 225 (+4.5%) received a massive boost from the rally on Wall Street. However, the Chinese (SSE: 0.0%) market traded in a lull following the observance of the Golden Week holiday in China. Elsewhere, the Emerging (MSCI EM: +4.0%) closed higher following gains in Taiwan (+2.1%) while the Frontier (MSCI FM: -0.6%) markets stocks declined due to bearish sentiments in Vietnam (-9.3%).

Nigeria

Economy

According to the recently released Q2-22 Budget Implementation Report (BIR) by the Budget Office of the Federation, the FGN’s fiscal deficit settled at NGN5.50 trillion (or 5.97% of prorated GDP) in H1-22 – 77.2% higher than the projected deficit (NGN3.10 trillion) for the review period. The increased deficit was primarily driven by a 41.4% shortfall in the FGN’s retained revenue (NGN2.41 trillion vs prorated budget: NGN4.12 trillion). We highlight that independent (64.3% underperformance) and oil (40.3% underperformance) revenue contributed a significant chunk of the retained revenue shortfall. Meanwhile, aggregate expenditure (NGN7.91 trillion) was 9.6% higher than the prorated budget (NGN7.22 trillion), driven by higher debt services payments (+31.3% vs prorated budget) and capital expenditure (+33.9% vs prorated budget). At this run rate, the fiscal deficit could settle at NGN11.00 trillion in 2022E (Cordros estimate: NGN9.74 trillion). Given that the external financing conditions are unfavourable, it implies that much of the deficit financing would be channelled towards the domestic debt market amid an increased reliance on the CBN’s Ways and Means (W&M) advance. Indeed, the actual W&M from the CBN was NGN4.61 trillion in 8M-22 (vs 2021FY: NGN4.35 trillion).

According to the Domestic and Foreign Portfolio Report of the Nigerian Exchange (NGX), total transactions in the domestic equities market increased by 22.5% m/m to NGN123.97 billion in August (July: NGN101.18 billion). Still, the print is significantly below the average monthly gross transactions (NGN235.88 billion) so far in 2022, reflecting the troika impact of (1) higher yields in the fixed income market, (2) lingering FX liquidity constraints, and (3) a lack of flexibility in the FX framework. For the review month, we highlight that the domestic transactions (77.2% of gross transactions) increased by 33.9% m/m to NGN95.76 billion while foreign transactions (22.8% of gross transactions) fell by 5.0% m/m to NGN28.21 billion. Notably, domestic investors were net sellers of equities since the MPC of the CBN started increasing the MPR, safe for July. In the short to medium term, we expect domestic investors to continue to dominate market performance, although rising FI yields may constrain buying activities. Also, FPIs who have exhibited a lacklustre interest in domestic equities are likely to remain on the sidelines due to sustained FX liquidity challenges and interest rate hikes by central banks in developed countries.

Capital Markets

Equities

The bearish momentum in the local bourse increased further as sustained profit-taking activities in blue-chip stocks drove the market to its fifth consecutive weekly decline. Thus, the All-Share index shed 3.4% to close at 47,351.43 points – the lowest level since April 2022. Notably, selloffs in bellwether stocks — AIRTELAFRI (-10.0%), OKOMUOIL (-10.0%), and PRESCO (-10.0%) drove the weekly loss. As a result, the YTD gain moderated to +10.9%. Activity levels mirrored the market’s broad gauge, as trading volume and value declined by 41.6% w/w and 15.1% w/w, respectively. Performance across sectors was largely bearish, as losses in the Banking (-3.4%), Insurance (-1.2%), Oil & Gas (-1.0%), Consumer Goods (-0.6%), and Industrial Goods (-0.3%) indices reflected the overall market sentiment.

We expect the weak sentiments that dominated the local bourse this week to persist in the week ahead as investors continue to scale down exposure to equities amidst expectations of a continued uptick in F.I. yields. Notwithstanding, we advise investors to take positions in only fundamentally justified stocks as the unimpressive macro story remains a significant headwind for corporate earnings.

Money market and fixed income

Money market

This week, the overnight (OVN) rate increased by 8bps, w/w, to 17.3%, following the already tight system liquidity. We highlight that the average system liquidity level settled lower this week but remained positive at a net long position of NGN113.17 billion (vs a net long position of NGN182.97 billion in the previous week).

We expect the OVN rate to trend northward next week, as the thin inflow from OMO maturities (NGN10.00 billion) may not be sufficient to keep system liquidity afloat.

Treasury bills

The bears dominated the Treasury bills secondary market this week as market participants exited positions to provide some respite to their funding obligations. Consequently, the average yield across all instruments expanded by 17bps to 7.9%. However, across the segments, the average yield dipped by 2bps to 10.3% at the OMO secondary market, while most of the yield expansion was witnessed at the NTB segment (+17bps to 7.3%).

Given the tight liquidity picture, we still expect the average yield on T-bills to maintain its uptick next week. Also, we expect quiet trading at the NTB market as participants position for next week’s PMA, with NGN190.89 billion worth of maturities on offer.

Bonds

Trading in the Treasury bonds secondary market was broadly bearish this week, as demand for FGN bonds remained tepid. We believe this reflects expectations regarding higher yields in the near term. Consequently, the average yield expanded by 24bps to 13.5%. Across the benchmark curve, the average yield was higher at the short (+49bps), mid (+11bps), and long (+17bps) segments, following sell-offs of the MAR-2024 (+177bps), APR-2032 (+21bps), and MAR-2035 (+52bps) bonds, respectively. 

We maintain 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 level over the rest of the year.

Foreign Exchange

This week, Nigeria’s FX reserves decreased by USD153.59 million w/w to USD38.10 billion (06 October 2022). Across the FX windows, the naira depreciated by 0.5% to NGN439.17/USD at the I&E window (IEW) but appreciated by 0.7% to NGN735.00/USD in the parallel market. At the IEW, total turnover (as of 06 October 2022) decreased by 42.5% WTD to USD325.29 million, with trades consummated within the NGN425.00 – 460.00/USD/USD band. In the Forwards market, the rate appreciated across the 1-month (+0.2% to NGN445.94/USD), 3-month (+0.3% to NGN452.02/USD), 6-month (+0.2% to NGN467.08/USD) and 1-year (+0.7% to NGN491.70/USD) contracts.

Although the CBN has enough liquidity to support the F.X. market over the short term, we highlight that foreign inflows are paramount for sustained F.X. 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 F.X. 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.