WED 17 FEB, 2021-theGBJournal- In their 2021 domestic macroeconomic outlook report, Cordros Securities analysts projected that the CBN would adopt a combination of higher yields on OMO bills and further devaluation of the local currency to lure foreign portfolio investors back into Nigeria in a bid to solve the liquidity crunch in the foreign exchange market.
This CBN’s action since then has had significant implications on the FX, fixed income and equities markets and recent happenings in the OMO segment of the Treasury bills market and the FX market suggests this may have come earlier than expected.
The actions from the monetary authority was necessitated by the need to reverse the trend of declining Foreign Portfolio Investment inflows since Q1-20 and enable the country to benefit from the global hunt for yields, given the low-to-negative yields in advanced economies.
At the February 4, 2021 OMO primary auction, the CBN more than doubled the yields on instruments sold, increasing the average stop rate by 467bps to 8.5%. The stop rate of the longest dated instrument (362-day) closed at 10.1% (previous stop rate: 5.7%) – the highest level since the April 30, 2020 auction (12.6%).
This occurred despite the auction being undersubscribed and the CBN allotting c.90% of the total amount offered on each tenor. Interestingly, there was limited participation from local banks due to the tight liquidity conditions arising from CRR debits and FX retail auctions during that week.
This occurrence, whether coincidence or not, left the auction, and higher rates mostly to foreign investors. Cordros Securities analysts view is that the hike in stop rates was done majorly to ignite FPI interest which would support US dollar inflows.
‘’While we believe this is a necessary condition to attract Foreign Portfolio investors (FPIs), we think it is insufficient given yields are still relatively lower than African peers, FX liquidity is still thin despite the accretion in FX reserves, and the CBN is yet to communicate clear guidelines on its FX policies,’’ Cordros said.
Considering that the key issues that have kept foreign investors away for almost a year still linger on, the CBN will have to offer even higher yields to elicit FPI interest.
The CBN will have to keep OMO rates at current levels, at least, to show strong intent, as there is a strong possibility that participants in the market, especially FPIs, will continue to make aggressive bids to test the apex bank’s resolve.
In this regard, Cordros analysts expect demand for higher yields in the Treasury bonds secondary market, especially for longer-dated instruments, to intensify, considering the increased rates on short term instruments.
‘’Thus, at this week’s FGN bond auction, we expect aggressive bids from investors, as they seek higher premiums. Overall, we expect auction stop rates to close higher.’’
In the equities market, the bearish sentiments (ASI is down 4.3% from its 2021 peak) that have dominated market performance over the last eight trading sessions indicate domestic investors are increasingly worried about the changing dynamics in the yield environment.
Cordros expects dividends announcements that will accompany 2020FY earnings releases to support market performance in the short term.
Notwithstanding, there is the possibility that increasing fixed income yields will temper demand for stocks, as investors scale down their positions in anticipation of higher yields in the Fixed Income market amidst the unimpressive macro story.
On the outlook for the currency (Naira), the CBN’s recent hawkish actions are in contrast to the forward guidance provided at the January MPC meeting. Cordros say they think the apex bank has come to terms with the fact that attracting portfolio investments is crucial in easing the liquidity constraints in the FX market.
‘’With the NDF rates being adjusted, it only makes sense for a proportionate adjustment in the spot rate for there to be a balance or convergence between the two rates. Although convergence does not necessarily need to happen, we still think it suggests that devaluation is imminent and will come earlier than we expected.’’
Instead of a one-off depreciation of the naira, we think the CBN will gradually weaken the local currency until it reaches its desired level. This appears to be in play already – the IEW spot rate has inched higher gradually to NGN409.67/USD (February 15) since the NDF was revised.
‘’Our baseline expectation for the naira remains unchanged; we expect that the naira will depreciate to NGN415.00/USD at the Investors and Exporters Window (IEW),’’ says Cordros.
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