At its first meeting of the year, the Federal Open Market Committee (FOMC) implemented the lowest rate hike since March 2022, increasing the target range for the Fed funds rate by 25bps to 4.50% – 4.75% (previously: 4.25% – 4.50%). Furthermore, the Committee reiterated that it anticipates that ongoing increases in the target range would be appropriate to attain a sufficiently restrictive monetary policy to return inflation to 2.0% over time. Nonetheless, the FOMC stated that in determining the extent of future rate increases, it would take into account the cumulative tightening of monetary policy, lagging impacts of monetary policy, and economic and financial developments. At the December 2022 policy meeting, the Fed penciled in rate increases until it hit a median level of 5.125% (equivalent to a target range of 5.00% – 5.25%) in 2023. Thus, given a 25bps hike at the February meeting and the tone of the FOMC, it suggests two more hikes in 2023 – 25bps apiece in March and May. However, the market is currently pricing in peak rates of just below 5.00%, as the expectation is that the Fed will start to cut rates later this year after one more 25bps increase in March.

The Monetary Policy Committee (MPC) of the Bank of England (BOE) increased the key policy rate for the tenth consecutive time, with members voting by a majority of 7- 2, to hike the bank rate by 50bps to 4.0% – the highest rate since October 2008 (4.50%). In its assessment, the Committee noted that inflation has begun to ease and is likely to fall sharply over the rest of the year due to past movements in energy and other goods prices. However, the labour market remains tight, and domestic price and wage pressures have been stronger than expected, suggesting risks of greater persistence in underlying inflation. In its guidance, the BOE stated that it would adjust the Bank Rate as necessary to sustainably return inflation to the 2% target in the medium term, in line with its remit. Accordingly, we align with the Committee that further rate hikes, albeit slowly, would be needed in the short term if underlying inflationary pressures do not show signs of slowing.

Global Markets

Global stocks posted broadly positive performances as investors digested key central bank decisions, economic data, and corporate earnings. In line with this, US equities (DJIA: +0.2%; S&P 500: +2.7%) are on course for a weekly gain as better-than-expected earnings from Meta, and the Fed’s dovish remarks supported sentiments. Likewise, European equities (STOXX Europe: +0.9%; FTSE 100: +0.7%) remained resilient as the European Central Bank’s (ECB) hawkish comments failed to derail investor hopes of an end to the global rate hiking cycle. In Asia, the Japanese market (Nikkei 225: +0.5%) edged higher as sentiments remained cautious in anticipation of US nonfarm payroll data. On the other hand, Chinese equities (SSE: 0.0%) struggled for direction amid a dearth of positive triggers. Elsewhere, the Emerging (MSCI EM: -0.5%) market index declined following selloffs in South Korea (-0.2%), while the Frontier (MSCI FM: +0.4%) market index inched higher, supported by gains in Morocco (+2.7%).

Nigeria

Domestic Economy

On Friday, 27 January, Moody’s Investors Service (“Moody’s”) downgraded Nigeria’s sovereign credit rating further to ‘Caa1’ from ‘B3’ and changed the outlook to ‘Stable’. We note that obligations rated ‘Caa1’ are judged to be of poor standing and are subject to very high credit risk. The rating agency stated that the review for downgrade focused on Nigeria’s fiscal and external positions and the capacity of the government to address the ongoing deterioration – other than by alleviating the burden of its debt through any form of default, including debt exchanges or buy-backs. Nonetheless, Moody’s noted that immediate default risk is low, provided that no sudden or unexpected events (such as another shock or shift in policy direction) would raise the default risk. Thus, the rating agency gave Nigeria a stable outlook. A significant implication of the downgrade is that Nigeria will find it difficult to access the foreign currency debt market in the short-to-medium term as investors price in the risk of default into the cost of debt amid the lingering increase in global interest rates. Read more here.

The Central Bank of Nigeria (CBN) recently released the Q3-22 balance of payment data and revised the figures downwards for Q1-22 and Q2-22. To put into proper context, the current account balance (CAB) returned to a deficit position in Q3-22, settling at USD603.14 million or -0.5% of GDP (Q2-22: USD860.62 surplus | Q1-22: USD1.27 billion deficit). The deteriorating external position in the review period reflects (1) a significant decline in trade balance surplus (-15.7% q/q), (2) a wider primary income account deficit (+34.5% q/q) because of higher repatriation of dividends & profits, and (3) higher deficit in the services account (+4.7% q/q). At this rate, the CAB is on course to settle in a deficit position in 2022E, other things being equal. That said, our revised estimates for 2023FY imply that the CA balance may likely settle in a USD2.16 billion surplus (2022E: USD1.19 billion deficit) given our expected positive outlook on trade balance supported by higher crude oil production volume amid lingering pressures on the services and primary income account deficits.

Capital Markets

Equities

The domestic stock market consolidated the gains recorded in the prior week as bargain-hunting dominated activities during all trading sessions of the week. Thus, the All-Share Index advanced by 2.9% w/w to close at 54,202.58 points. Notably, buying interests in MTNN (+5.7%), GEREGU (+36.9%), and SEPLAT (+11.8%) drove the weekly gain, and partly propelled the market to MTD and YTD returns of +1.8% and +5.8%, respectively. Activity levels mirrored the overall market gauge, as trading volume and value surged by 399.8% w/w and 101.0% w/w, respectively. Sectoral performance was broadly positive, as the Oil and Gas (+9.2%) index recorded the most significant gain, followed by the Banking (+2.5%), Insurance (+0.3%), and Industrial Goods (+0.1%) indices. On the flip side, the Consumer Goods (-0.4%) index was the sole loser for the week.

In the subsequent weeks, we expect the NGX to be flooded with corporate earnings as more companies publish 2022FY numbers, which will be accompanied by dividend declarations. We believe this should provide a catalyst for buying activities even as risk-averse investors are likely to remain cautious due to medium-term expectations of an uptick in FI yields. Overall, we advise investors to seek trading opportunities in only fundamentally justified stocks as the weak macro story remains a significant headwind for corporate earnings.

Money market and fixed income

Money market

This week, the overnight (OVN) rate expanded by 6bps, w/w, to 11.1%, as the outflows for the FGN bond auction (NGN662.62 billion) and late CRR debit pressured the system liquidity amid the inflow of redesigned naira notes from CBN (c. NGN400.00 billion). We note that the average system liquidity settled at a net long position of NGN728.11 billion (vs. a net long position of NGN837.61 billion in the previous week).

Next week, system liquidity will be supported by the inflow of OMO maturities of c. NGN40.00 billion. However, we expect the OVN rate to trend upwards, as we believe the CBN will most likely mop up the excess liquidity from the system.

Treasury bills

The buoyant liquidity in the system continues to trigger bullish sentiments in the Treasury bills secondary market, as the demand for OMO bills supported the lower yields in this space this week. As a result, the average yield across all instruments dipped by 8bps to 1.7%. Across the market segments, the average yield contracted by 89bps to 2.0% in the OMO segment but expanded by 12bps to 1.6% in the NTB secondary market.

In the coming week, we believe yields for T-bills will increase slightly in the secondary market following the anticipated liquidity squeeze next week. Also, we expect participants in the NTB market auction to shift their focus to the primary market, with the CBN expected to roll over maturities worth NGN217.06 billion.

Bonds

The FGN bonds secondary market traded with bullish sentiments this week, as investors sold off their positions across the spectrum of the benchmark curve. Consequently, the average yield expanded by 13bps to 13.2%. Across the benchmark curve, the average yield expanded at the short (+1bp), mid (+18bps), and long (+15bps) segments due to the profit-taking activities on the MAR-2024 (+25bps), NOV-2029 (+24bps), and APR-2049 (+66bps) bonds. At Monday’s bond PMA, the DMO offered instruments worth NGN360.00 billion to investors through re-openings of the 13.98% FGN FEB 2028 (Bid-to-offer: 2.1x; Stop rate: 14.00%), 12.50% FGN APR 2032 (Bid-to-offer: 1.1x; Stop rate: 14.90%), 16.25% FGN APR 2037 (Bid-to-offer: 2.9x; Stop rate: 15.80%), and 14.80% FGN APR 2049 (Bid-to-offer: 2.9x; Stop rate: 15.90%) bonds. Demand was higher across the four instruments as the total subscription level settled higher at NGN805.16 billion (vs. NGN532.20 billion in the previous auction), with the DMO allotting instruments worth NGN662.62 billion (translating to a bid-to-cover ratio of 1.2x).

In the medium term, we expect the FG’s frontloading of significant borrowings for the year to result in an uptick in bond yields, as investors demand higher yields in the face of elevated supply.

Foreign Exchange

Nigeria’s FX reserves declined for the third consecutive week, as the gross reserve position fell by USD30.67 million w/w to USD37.01 billion (01 February 2023). Meanwhile, the naira appreciated by 0.1% to NGN461.50/USD at the I&E window (IEW), with total turnover at the window (as of 02 February 2023) declining by 7.5% WTD to USD460.25 million, as trades were consummated within the NGN423.00 – NGN479.42/USD band. In the Forwards market, the 1-month (-0.8% to NGN483.43/USD) and 3-month (-0.2% to NGN489.61/USD) contracts recorded depreciation, while the 6-month (+0.1% to NGN506.18/USD) and 1-year (+9.3% to NGN487.41/USD) contracts appreciated.

We believe the FX liquidity issues will remain over the short-to-medium term as we do not see any positive signal that denotes an improvement in FX supply relative to the pre-pandemic levels. Moreover, considering the tepid accretion to the reserves given (1) low crude oil production 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 significantly attract foreign inflows back to the market.