January 24, 2020/Cordros Report
In line with market expectations, the European Central Bank’s (ECB) governing council, in its first-rate decision of the year, voted unanimously to keep the benchmark rate at the historic low of -0.5% and stated that the rate will remain unchanged until inflation, which is currently at 1.3%, is sufficiently close to or at par with its 2.0% target. The ECB also decided to keep the pace of monthly bond buying at EUR20.00 billion as it seeks to boost the bloc’s struggling economy. The council also announced the review of its monetary policy strategy regarding (1) price stability, (2) monetary policy toolkit and (3) economic & monetary analyses. In our view, the growing awareness that the ECB has broadly reached the limits of what monetary policy can do to support growth and inflation without creating more adverse effects has forced the ECB to maintain a wait-and-see stance. Consequently, any substantial change of the ECB’s monetary policy stance, including forward guidance, before the end of the strategy review seems unlikely.
Japanese exports dropped more than expected in December, with the shipments slump dragging on for a 13th month despite recent positive signs of recovery in global manufacturing. Exports fell by 6.3% y/y weighed down by sliding exports of cars and auto parts. Still, the report also showed strong gains in shipments of semiconductor-making equipment, adding to evidence of a bottoming of the global tech cycle. Exports to China, the country’s single biggest overseas market, also inched up for the first time in 10 months. We expect the country’s Q4-19 GDP report to show that the economy shrank in the final quarter of 2019, given the negative effects of the US-China trade war on exports, as well as the October 1 sales tax hike which weighed on private consumption. However, the phase-one trade deal between the US and China is expected to impact the Japanese economy positively by spurring demand from China (Japan’s largest trading partner).
Sentiments were weak across global equities markets this week, as worries over the coronavirus outbreak in China took precedence. Consequently, US (DJIA: -0.6%; S&P: -0.1%) and European (Euro Stoxx: -0.5%; FTSE 100: -0.6%) markets were down, w/w, at the time of writing. In addition to outbreak fears, trading in Asia (Nikkei 225: -0.9%; CSI 300: -3.6%) also slowed down due to the Lunar New Year holiday. Weighed by the losses in China, the emerging markets (MSCI EM: 2.1%) equities markets gauge was set to log its first weekly decline since November, snapping a seven-week rally. Conversely, gains in Vietnam (+1.3%) drove the Frontier (MSCI FM: +1.4%) markets index to its eleventh consecutive weekly gain.
The Monetary Policy Committee (MPC), in its first-rate decision of the year, took a striking decision by electing to adjust the Cash Reserve Ratio (CRR) upward by 500bps to 27.5%, while holding all other parameters constant. While the committee highlighted increasing concerns around sustained inflationary pressure, which has persistently run ahead of the CBN target of 6.0% – 8.0%, its disposition reflects signs of the ineffectiveness of monetary policy tools in curbing consumer price pressures. Nonetheless, amidst concerns of impending OMO maturities which are expected to significantly increase financial system liquidity, the 9 members of the monetary committee elected to increase the CRR. In our view, despite bourgeoning system liquidity, the imperative to drive credit extension to the private sector in a bid to support economic growth essentially nullifies any argument for a rate hike over 2020.
According to the October 2019 Monthly Financial and Operations Report by NNPC, Nigeria’s crude production (oil and condensates) declined by 3.9% m/m to 2.07 mb/d in September 2019 – c.10.0% lower than the 2019 budget estimate of 2.30mb/d. The production decline was attributed to shutdowns of the Trans-Forcados and Nembe Creek Lines due to repairs and leaks. Meanwhile, petrol subsidy expenses settled at NGN434.66 billion as of July 2019 – 67.0% of the total amount expended in 2018 (NGN648.27 billion). Looking ahead, higher crude oil prices, together with the still inefficient domestic refineries (October capacity utilisation was 0.0%) should leave under-recovery expenditure elevated, further exerting pressure on Nigeria’s public finances. Nonetheless, the chance of a PMS price upward review in 2020 is low in our view.
Sentiments were mixed on the domestic bourse as cement sub-sector driven gains were offset by selloffs across the equities of companies in the Consumer Goods and Banking sectors. Consequently, the ASI closed marginally higher (0.03%) for the week, with the year-to-date return settling slightly higher at +10.4%. Analysing performances by sectors, the Industrial Goods (+5.1%) index led gains following investors’ interest in DANGCEM (+2.8%), BUACEMENT (+2.80%) and WAPCO (+10.8%). Similarly, gains were recorded in the Insurance (+3.0%) and Oil & Gas (+2.5%) sectors. However, the Consumer Goods (-3.6%) and Banking (-2.6%) sectors recorded losses, following selloffs of NESTLE (-6.1%) and GUARANTY (-4.2%).
Looking ahead, while we expect profit-taking to continue in the coming week, we still see significant legroom for a further rally as the elevated maturities from fixed income instruments hunt for investment vehicles. Nonetheless, we advise investors to cherry-pick fundamentally sound stocks.
Fixed income and money market
In line with our expectations, the overnight lending rate expanded by 140 bps to 4.3%. The rate declined till mid-week following inflows from FAAC disbursements (NGN476.00 billion), matured OMO bills (NGN433.76 billion) and bond coupon payments (NGN42.10 billion). However, outflows from OMO auction (NGN 240.29billion) and bond auction debits (NGN409.99 billion) in the latter part of the week drove the rate higher.
In the coming week, inflows worth NGN924.72 billion are expected to hit the system from OMO (NGN695.08 billion) and NTB (NGN229.64 billion) maturities. This, we expect will keep the OVN rate depressed in the coming week.
Trading in the Treasury bills market was bullish this week, as the average yield across instruments decreased by 13bps to 9.6%. The NTB segment of the market was bearish due to weak trading volumes (average daily volume: -14.9% w/w); retail demand constituted majority of the activity. Consequently, the average yield rose by 8bps to 3.5%. Conversely, the OMO segment was slightly bullish as the average yield contracted by 34bps to close at 12.8%. At the OMO auction on the 23rd of December, the CBN sold instruments worth NGN240.29 billion – 180DTM (NGN13.99 billion) and 362DTM (NGN226.31billion) – at respective stop rates of 11.67% (same as the previous auction), and 13.11% (previously 12.50%); no sales were recorded at the short segment.
We expect trading volumes to increase and yields to further trim in the NTB market, as OMO maturities are expected to flood the market in the coming week. However, we do not expect any significant movement in the OMO rates as the CBN will likely mop-up maturities in the coming week.
Trading in the Treasury bonds secondary market was bullish, as investors scrambled to cover lost bids at the primary auction. Consequently, the average yield across instruments settled 41bps lower at 10.1%. At the auction, three instruments worth NGN150.00 billion were offered to investors through re-openings – 12.75% APR 2023 (Bid-to-offer: 1.62x; Stop rate: 9.8500%), 14.55% APR 2029 (Bid-to-offer: 4.04x; Stop rate: 11.1250%), and 14.80% APR 2049 (Bid-to-offer: 6.21x; Stop rate: 12.5600%). The DMO eventually allotted instruments worth NGN409.99 billion, representing 2.73x the offer amount.
Considering the level of subscriptions witnessed at the PMA, we maintain the view that trading activity will remain elevated. Also, we expect the favourable yields in the space to drive interest in the market and therefore drive up volumes.
Amidst continued sell-offs by offshore investors, Nigeria’s FX reserve dipped by USD88.29 million WTD to USD38.25 billion (17th Jan 2019). Nonetheless, the naira strengthened by 0.3% w/w at the I&E window to NGN362.75USD but closed flat at NGN362.00/USD in the parallel market. Meanwhile, the CBN sustained its weekly FX interventions, selling USD210.00 million across the different segments of the FX market – USD100.00 million to the Wholesale segment, USD55.00 million to the SMEs segment, and USD55.00 million to the Invisibles segment. Total turnover at the I&E window decreased by 71.4% WTD to USD519.49 million, with trades consummated within the NGN357.00 – 363.88/USD band. In the Forwards market, the naira was stronger across the 3-month (+0.3% to NGN366.91/USD), 6- month (+0.6% to NGN373.04/USD) and 1-year (+1.7% to NGN398.12/USD) contracts. Conversely, the rate on the 1-month contract (-0.1% to NGN364.18/USD) weakened.
Despite the rate of decline in FX reserves, which has heightened fears regarding the possibility of a currency devaluation, our model suggests that the CBN has enough ammunition to sustain its naira defense through to at least H1-20.