August 16, 2019/Cordros Report
According to the U.S National Bureau of Statistics CPI report, inflation for July, in line with the consensus estimate, widened by 2 bps to 1.8% y/y. The renewed uptick in inflation was spurred by a marginal increase in food inflation to 1.8% y/y (June: 1.9% y/y) and core inflation to 2.2% y/y (June: 2.1% y/y), following increases in food prices and medical care services respectively. On the flip side, we noted that energy prices moderated sharply by 2.0% y/y, following significant contraction in gasoline and fuel oil costs. With the inflation rate still below the US Fed’s target of 2.0%, the case for a further rate cut at the September policy meeting is strong, however, we believe the US Fed would be content with inflation trending above the target level over the short term. Meanwhile, in terms of upside risk, we identify the implementation of U.S tariffs on non-retail consumer goods imported from China, which is expected to commence in September 2019.
According to the Federal Statistical Office (FSO), in Q2-19 the German economy grew at a slower pace of 0.4% y/y (Q1-19: 0.9% y/y) – the slowest growth rate in 24 quarters. As at the time of writing, the full breakdown was yet to be released, however, given that we have tracked and monitored manufacturing activities in Germany closely, we have noticed significant contraction across the country’s manufacturing PMI and industrial output data, owing to a significant contraction in exports. In the short to medium term, we still expect the sluggish economic growth to persist, partly due to US-China trade concerns, Brexit uncertainties, and the country’s ailing automobile industry.
In the U.S, economic recession fears heightened this week, given the inversion of the Treasuries yield curve, which further stoked concerns regarding global growth. Consequently, risky assets prices plummeted across our coverage as investors piled into safer haven assets. Beyond that, weaker retail sales data in China and a benign economic growth reading in Germany were equally not supportive. For evidence, the U.S (DJIA: -2.7%, S&P: -2.4%) and Euro Area (FTSE: -1.8%, Euro Stoxx: -0.5%) were all recording negative week-on-week returns as of the time of writing. Meanwhile, the performances across Asian markets were mixed (CSI 300: +2.1%; Nikkei: -1.3%), partly due to the postponement of U.S tariffs on retail goods from China. Elsewhere, sentiments were negative across Emerging (MSCI EM: -1.8%) and Frontier (MSCI FM: -0.3%) Markets, following losses in Brazil (-4.7% w/w), and Nigeria (-1.4% w/w).
With the dust of FX restriction on milk importation still in the air, it was reported in the week that President, Muhammadu Buhari, directed the CBN to restrict FX for the importation of agricultural produce. Although neither the FG nor the CBN has provided clarity on this possible directive, we highlight that Nigeria is far from being self-sufficient in the production of most agricultural produce. For clarity, as at June 2019, the supply-demand gap for rice, wheat, and corn stood at deficits of 2.4MMT, 5.6MMT, and 400TMT respectively. In our view, the possible FX restriction policy on agriculture produce could stoke currency pressures if importers resort to sourcing FX in the parallel market. Elsewhere, we highlight that imported food basket constitute c.13% of the total CPI, thus, limited supply of agricultural products due to US dollar illiquidity could put upward pressure on food prices. Nonetheless, the true impact can only be assessed when full information regarding this directive has been provided.
For the second consecutive month, Nigeria’s headline inflation reading decelerated. July inflation slowed by 14 bps to 11.08% y/y – the lowest reading since Feb 2016. The moderation was primarily driven by lower food prices (-10bps) as well as a marginal decline in core inflation (-1bp). Looking ahead, we expect inflation to dip further in the coming months. Our view is hinged on the expectation of a significant increase in the supply of farm produce as the main harvesting season enters full force, as well as stability in energy prices. Overall, we expect headline inflation to print 10.90% y/y for August (0.89% m/m).
Despite the shorter trading week, following the 2-day public holiday, Nigeria’s equities market significantly extended its bearish run, as the benchmark index shed 1.4% w/w to settle the index level at 26,925.29 points. The sell-offs were broad-based as all sector indices closed negative. Evidently, the Banking (-1.1%), Consumer Goods (-6.6%), Oil & Gas (-1.9%), Industrial (-1.2%), and Insurance (-0.7%) indices all recorded declines.
Going forward, we still hold the view that the blend of a compelling valuation story, together with a positive macroeconomic picture leaves scope for market recovery over the medium term. However, we guide investors to thread the cautious trading path in the short term.
In line with our expectation, the overnight lending rate expanded by 586 bps w/w to 18.00% on the back of the expansion in system liquidity. Rates undulated in the week, increasing by 1.72% on the first trading day before declining by 2.14% on the subsequent trading day. However, as system liquidity expanded to NGN219.17 billion on the penultimate trading day, the rate expanded.
Next week, we expect the rate to pare at the start of the week, however, as system liquidity declines from the planned Treasury bonds PMA, we expect the rate will rise.
Proceedings in the Treasury bills market were bearish in this shortened trading week, as risk-off sentiment given global growth concerns continues to underpin capital flow reversals. Consequently, the average yield across instruments in the secondary market increased by 128 bps to settle at 13.85%. Also, the CBN conducted OMO auctions selling a total of NGN150 worth of bills across – the 84DTM (NGN20.00 billion), 175DTM (NGN30.00 billion), and 364DTM (NGN100.00 billion) – were offered to investors. There were under subscriptions for the short and mid tenor instruments, with bid-to-cover ratio settling at 0.30x and 0.12x for the respective instruments. However, the 364DTM was oversubscribed, with the stop rate settling higher at 12.88% (previously: 12.25%), as the CBN seemingly firmed up the rate to retain FPIs from maturing OMO bills.
In the coming week, we expect the trend to be maintained as factors causing consternation within the market still remain. This view is maintained even with the expectation of an OMO in the coming week to mop-up liquidity from maturing instruments worth NGN92.31 billion on the 22nd of August.
The direction of trading in the Treasury bonds market was also bearish, as sell-offs continue to pressure yields upwards. Consequently, the average yield across instruments rose by 43bps w/w to settle at 14.24%. There were yields expansions recorded across all instruments save for the OCT-2019 bond, as the bond reverts to par. The DMO will be holding a Treasury bonds primary market auction next week, where three instruments will be offered (all through re-openings) – 12.75% FGN APR-2023, 14.55% FGN APR-2029, 14.80% FGN APR-2049.
Looking ahead, we believe that the intensifying sell-offs witnessed over the past few weeks will intensify as investors remain risk-off EM and FM given the rising global risk profile. Consequently, we expect yields to rise week-on-week.
Nigeria’s FX reserves declined by USD16.17 million w/w to settle at USD44.46 billion. Meanwhile, in the absence of CBN’s weekly FX intervention, the naira weakened by 0.06% w/w to settle at NGN363.46/USD at the I&E FX window but closed flat at NGN360.00/USD in the parallel market. Elsewhere, total turnover at the I&E window increased by 20.94% w/w to USD1.13 billion with trades executed within the NGN357.50-364.15/USD band. In the Forwards market, the FX rate in the 1-month (-0.1% to NGN366.90/USD) and 6-month (-0.4% to NGN385.81/USD) contracts declined but increased for the 3-month (0.1% to NGN373.01/USD) contract. The rate in the 1-year contract was flat at NGN402.75/USD.
Looking ahead, while we acknowledge the continuous depletion of reserves amidst sell-offs from offshore investors and the softer crude oil price, we still expect the naira to remain resilient in the short to medium term.