Brief Synopsis on Nigeria's Fixed Income Market.   

Election jitters to hit fixed income market 

Although a modest economic recovery and strong oil prices ought to make the Nigerian economy an attractive destination, uncertainty ahead of the 2019 elections is likely to induce more bearish activity. Firstly, analysts anticipate higher political spending in H2’18 to fund electioneering activities. This spending will pressure year-end inflation, which would likely manifest in higher yields. 

As such, analysts anticipate a yield uptick in the latter parts of the year and foresee reduced market activity as some investors opt to sit on the sidelines. 

All monetary policy levers expected to hold steady in H2 

Analysts have revised their monetary policy expectation for 2018 on the back of prevailing economic realities and their outlook for the rest of the year. They had initially expected a 200bps rate cut in mid-2018 amid down-trending inflation and the need to stimulate economic growth in a pre-election year. 

Whilst they have observed inflation decline as expected (380bps from December 2017 to May 2018), monetary policy levers were unchanged in H1’18 and they expect that to persist in 2019. Their revised outlook is hinged on an expected uptrend in inflation later in the year as the effects of the high base in H1’17 inflation wear off. In addition, they expect increased pressure on food prices given the impact of the prolonged herdsmen violence in the Middle Belt, while election spending and other fiscal injections should spur demand-pull inflation. 

Amid this, analysts expect the Monetary Policy Committee of the Central Bank of Nigeria (CBN) to prudently hold interest rates for the rest of the year whilst the apex bank persists with Open Market Operations as its primary liquidity management tool. Given this view of a stable monetary policy, analysts see very few drivers for material yield moderation between now and year-end. 

Government spending will spur inflation, but not bond supply 

Analysts anticipate greater government spending in the second half of the year, based on late passage of the 2018 Budget, a higher proposed expenditure and electioneering activities. Despite the expansionary budget, analysts do not expect this to lead to a ramp up in domestic borrowing given the healthy oil earnings expectation (supported by positive oil price outlook) and government focus on external debt raising. 

The 2018 Budget stipulates domestic borrowing of N850 billion, a material drop from the N1.52 trillion raised in the domestic debt market for the 2017 Budget, and analysts expect the FGN to favour the external debt market even more. Moreover, they note that the government has not exhausted its $3 billion (?915 billion) three-year T-bill refinancing facility obtained from the Eurobond market. So far, the government has refinanced ?478 billion (?198 billion at the end of December 2017 and ?280 billion in Q1’18), leaving ?437 billion to be refinanced within the next 2 years. 

Analysts note that this is unlikely to happen in Q3’18 as the released Nigerian Treasury Bills (NTB) calendar suggests a complete rollover of maturing debt. That said, analysts foresee more corporate bonds and commercial paper issuances in the near-term amid a lower yield environment, however, the volumes would be insufficient to compensate for the expected decline in FGN borrowing – a trend already observed in H1’18 (N50 billion sold in May 2018 vs N110 billion in May 2017).


Rising global rates and domestic uncertainty may dissuade FPI 

Foreign portfolio inflows (FPI) to Nigeria’s fixed income market have rebounded in recent times, rising from $30 million in March 2017 to $1.4 billion in March 2018 following the improvement in the foreign exchange market. Moreover, capital flows have stayed strong even amid yield moderation as the real rate of returns are attractive. However, ongoing monetary tightening in the U.S. is a growing concern to FPI in the fixed income market. 

The U.S. Federal Reserves hiked interest rates by 25bps to a range between 1.75% and 2.0% in June and is expected to deliver on two more hikes in 2018 whilst also persisting with balance sheet unwinding, both of which would push yields higher in the U.S. market and elsewhere – U.S. 1-year treasury yield has risen from 1.2% in June 2017 to 2.3% in June 2018. 

Analysts expect the usual trend of capital reversals from emerging markets as the spread between U.S. and emerging market yields shrink. The expectation of an improved risk environment in Nigeria would have caused us to be less disturbed by the closing spread in yields, however, with the risk environment heightened by imminent elections, analysts do not see any reprieve on this end. 

Analysts note that Nigeria’s re-inclusion in the JP Morgan Emerging Market Bond Index would offer a strong demand boost to FGN bonds, but are not optimistic of this occurring in 2018. All things considered, they anticipate reduced foreign demand for fixed income instruments in the near-term. 

Not much room to go lower in fixed income market 

In summary, despite the monetary policy levers remaining unchanged so far, analysts have seen yields moderate 169bps on average across the curve in the fixed income market this year, on the back of a looser liquidity tightening stance evidenced by the spotty spate of OMO auctions to mop-up liquidity compared to the same period last year. 

The primary drivers point to declining yields, led by moderating inflation (2017 average: 16.6% y/y, 2018F average: 12.0%) though analysts expect expansionary fiscal policy and fading base effects to cause a slight uptick in inflation in Q4’18. Moreover, bond supply is expected to moderate as the Federal Government (FGN) shifts focus to external debt issuance – the corporate and sub-national bond market remains too shallow to compensate for declining FGN bonds. 

However, the demand-side of the equation is less positive. Whilst analysts see the mooted re-inclusion in the J.P. Morgan Bond Index as a potential balm, they point to rising global interest rates and pre-election jitters as likely drivers of weaker foreign appetite for Nigerian debt. In particular, with the moderation in inflation likely to bottom out in Q3 analysts see elections looming larger at year-end weighing on demand in the fixed income market .

 Overall, they project a 25bps decline in yields in Q3 and a 125bps uptick in Q4 leading to a 100bps rise in yields for H2’18. 

Source: Analysts at Vetiva Capital Management

Reporting for EasyKobo on Wednesday, 27 June 2018, in Lagos, Nigeria.

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