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Fixed Income Market remains toast of investors as yields fall

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What shaped the past week?

Global Markets:  Global markets traded mixed this past week, with investors focused on announcements from various central banks as well as economic data. U.S. markets began the week on a positive note, driven by positive sentiment around tech and energy stocks coupled with optimism around the proposed tax reforms. While bullish trading strengthened at mid-week – after the U.S. Federal Reserve raised its 2018 GDP forecast to 2.5% from 2.1%, and raised Federal Funds target range to 1.25%-1.5%, the market promptly retreated on Thursday. Similarly, European markets were mixed through the week amidst a basket of economic events (UK inflation hit a 5-year high of 3.1% in November, BOE held rates constant, ECB also held rates constant but revised growth and inflation expectations upwards). Asian markets traded mostly bearish through the week amidst several corporate announcements and economic releases (Hong Kong increased its base rate by 25bps to 1.75%, China’s industrial output beat estimates in November and stronger manufacturing sentiment in Japan).

Domestic Economy:  The International Monetary Fund (IMF) suggested that despite strides taken to improve the liquidity, flexibility and transparency of Nigeria’s foreign exchange (FX) market, some international investors remain wary of having their funds trapped during a downturn. These comments came on the back of a spike in outflows from Nigeria’s fixed income instruments amidst a moderation in yields; at yesterday’s bond auction, the Debt Management Office sold the 10-year bond at a marginal rate of 13.21% compared to 14.80% in the previous month. However, we note that conditions in Nigeria’s FX market have relatively improved – reflected in external reserves surging to a 3-year high of $36 billion in December. Moreover, with oil earnings bolstered by relatively high prices and stable production, we maintain a positive outlook on FX dynamics in the medium-term.

Equities:    Trading turned sour on the Nigerian equity market this week as the bourse shed 209bps w/w. The market opened the week with the NSE ASI down 88bps in a broadly bearish trading session. Sentiment was broadly mixed on Tuesday (+3bps) evident in the nearly even market breadth and choppy intraday trading on the day. At mid-week, selloffs strengthened on the bourse with bears pushing the ASI 100bps down and this continued on Thursday (-156bps). At week close however, a green close in heavyweight DANGCEM offset the still bearish sentiment permeating the bourse, with the All Share Index notching 132bps. While the Consumer Goods (+68bps) and Oil & Gas (+454bps) sectors closed higher w/w, the Industrial Goods (-479bps) and Banking (-533bps) sectors recorded sizable selloffs for the week.

Fixed Income:              With the CBN sustaining its suspension of daily OMO auctions, the fixed income market was in positive spirits through the week. Further supporting upbeat sentiment was the CBN’s announcement to redeem all maturing PMA T-bills till the end of the year, using proceeds from the $3 billion Eurobond issue. Amidst the healthier liquidity and resulting buying pressure, yields consistently declined across the T-bills space. Bond yields were further guided lower by stop rates at the final bond auction for the year held at mid-week. The DMO sold N78 billion (Offer: N100 billion) across the 5-year and 10-year tenors at respective levels of 13.19% and 13.28%, markedly lower than respective rates of 14.79% and 14.80% at the previous auction. Finally, boosted by total T-bills inflows on Thursday, yields in the T-bills market dipped 276bps on average w/w, while yields on benchmark bonds declined 69bps on average w/w.

Currency:   The CBN continued to support foreign currency liquidity through interventions in the FX market. Notably, the apex bank injected $210 million into the interbank market, earmarking $100 million for the wholesale market, $55 million for SMEs & individuals and $55 million for school and medical fees. Overall, the naira depreciated N1.50 and N0.55 at the parallel market and NAFEX windows respectively to settle at N363.00 and N360.96 against the dollar

What will shape markets in the coming week?

Equity market:   Notwithstanding the green close today, market sentiment remains tepid – indicated by negative market breadth as well as notable losses across several stocks. Consequently, we foresee further bearish trading at week open.

Fixed Income market:   Given market expectation of a continued halt in daily mop ups by the CBN as well as anticipation of lower rates in the near term, we expect a positive start to the week in the fixed income space, further supported by healthy system liquidity.

Currency:    We expect the CBN to continue to intervene in the currency market and thus expect liquidity to remain at current levels.

Focus for the week

NIGERIA CURRENT ACCOUNT – Oil exports lift current account to 3-year high

Driven by the highest quarterly exports in three years, Nigeria’s current account surplus rose to N1.2 trillion in Q3’17 (Q1’17: N719 billion, Q2’17: N506 billion), the highest since the 2014 oil price slump. The quarter’s performance was helped by a simultaneous increase in exports – N3.1 trillion to N3.6 trillion – and moderation in imports – N2.6 trillion to N2.4 trillion compared to Q2’17.

Oil recovery buoys current account

Accounting for 83% of total exports (previous: 78%), the surge in crude exports was the main driver of Nigeria’s strong export performance. With oil prices little changed q/q ($52.19/bbl in Q3’17 vs. $50.79/bbl in Q2’17), stronger oil earnings came on the back of continued improvements in domestic oil production. According to the Ministry of Petroleum Resources, average oil production for the quarter rose from 1.87 mb/d in Q2’17 to 2.03 mb/d in Q3’17, touching a 2017-high of 2.08 mb/d in August. In terms of export destinations, India (19%) remains Nigeria’s most important crude oil buyer, though the United States (15%) increased their crude imports from Nigeria by 66% q/q. Relatively stronger oil prices in the final quarter of the year (average of $60.26/bbl in October and November) and stable oil production (average: 2.03 mb/d in October and November) point towards another strong export performance for Q4’17. Going into 2018, stronger full-year oil output numbers (forecast: 2.10 mb/d) and relatively healthy global oil prices (IMF forecast: $51.00/bbl) would buoy Nigeria’s exports.

Whither diversification?

At just N126 billion and 3.5% of total exports, Nigeria’s Q3’17 non-oil exports came in at their weakest in 2017. This highlights the limited impact of endeavors aimed at diversifying Nigeria’s export revenues, such as the Zero-oil initiative. It also reflects the natural lag of reaping the fruit of non-oil export initiatives and the long road to diversification. Moreover, we note that there are positive signposts on the route. The review and revival of the Export Expansion Grant (EEG) at the start of 2017 and stable budgetary allocations (N20 billion) should provide tax incentives for prospective exporters.  Furthermore, the proposed $1 billion Badeggi Export Processing Zone (EPZ) in Niger State could significantly boost access to market for Nigeria’s key agriculture produce such as rice, yam, and maize. Whilst the EPZ is slated to open in 2018, challenges with securing counterpart funding ($250 million provided by Turkish partners) may delay the process. Nevertheless, we stress the potential of well-executed EPZs in providing a stable platform for the diversification of export revenues.

Strong FY’17 current account surplus in sight

Crude oil sales will continue to drive Nigeria’s current account and given our positive outlook on this front, we foresee current account coming in strong going forward. If Q4’17 is as good as even the weakest quarter seen so far in 2017 (Q2), FY’17 current account surplus would be the highest since oil prices slumped in 2014 – reflecting the conclusion of Nigeria’s current account cycle since that point. Despite this, we note that 2014 current account surplus was still significantly stronger (N8.9 trillion vs. 2017 ytd: N2.4 trillion) and looks unattainable in the short-term given prevailing oil prices. On the import front, we expect relatively high global energy prices to slightly increase the value of imports given the price inelasticity of petroleum product demand. Overall, we expect Nigeria’s recovering current account to support dollar inflows.

Disclaimer

Whilst reasonable care has been taken in preparing this document to ensure the accuracy of facts stated herein and that the ratings, forecasts, estimates and opinions also contained herein are objective, reasonable and fair, no responsibility or liability is accepted either by Vetiva Capital Management Limited or any of its employees for any error of fact or opinion expressed herein.

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