The recent rise
in Nigeria’s headline inflation signals that the purchasing power of the
country’s bonds future cash flows has been eroded.
Nigeria’s headline inflation in May,
picked up from 8.7 percent year-on-year (yoy) to 9 percent, against most
analysts expectation of circa 8.8 percent, yoy.
To hedge against this potent risk
occasioned by bond’s worst enemy (inflation), Nigerian bond investors
may be fielding for higher yield to compensate inflation risk.
This situation is more realistic,
following recent weak demand from offshore investors, since JP Morgan’s
‘threat’ to delist Nigeria from its local currency government bond
indices weighs appetite.
“We expect local currency bond yields to
rise, in line with the current short-term inflation trend and consequent
depreciation on bond prices,” said research analysts at Lagos-based
Cowry Asset Managment Limited.
In the bond market, if participants
believe that there is higher inflation in the horizon, interest rates
and bond yields will rise (and prices will decrease) to compensate for
the loss of the purchasing power of future cash flows. Those bonds with
the longest cash flows will see their yields rise and prices fall the
most.
The Debt Management Office (DMO) will
today (Wednesday) hold its next monthly auction of FGN bonds in a
targeted raise of N80billion.
At today’s FGN bond auction, the DMO
will issue N40 billion, N15.22 billion and N25 billion worth of 15.54
percent February 2020 (5year), 14.20 percent March 2024 (10year) and
12.149 percent July 2034 (20year) bonds (all re-openings) respectively.
“The liquidity constraints forming the
basis of JP Morgan’s threat to delist Nigeria from its local currency
government bond indices are a powerful disincentive.
The auction should show the continuing
appetite of the Pension Fund Administrators (PFAs) for the 20-year
benchmark,” said analysts at Lagos-based investment house, FBN Capital
Limited.
The Tola Odukoya led team of bond market
analysts at Dunn Loren Merrifield said, “The level of market volatility
is expected to reduce as we approach the FGN bond primary auction due on
Wednesday (today) during which N80.22billion worth of bonds will be
offered”.
The analysts noted that Nigeria’s
Over-the-Counter (OTC) fixed income market was last week, influenced by
OMO bills auctions and redemptions; the release of June 2015 FGN bond
auction offer circular by DMO; net CRR credit; and the news of JPMorgan
extending Nigeria’s Government Bond-Emerging Market (GBI-EM) index watch
inclusion period, which stimulated initial demand from domestic
investors.
However, towards the mid to end of last
week, the market became bearish, as diminishing market liquidity spurred
increased selling activities, whilst dealers took positions ahead of
today’s bond auctions.
“Consequently, bond yields lost 53basis
points on the short end but gained about 27 basis points on the mid-long
end of the curve,” according to Dunn Loren Merrifield analysts.
The report for May from the National
Bureau of Statistics (NBS) reflects the negative impact of both the fuel
shortages and the late start of the rains, analysts added.
“The headline rate now sits at the top of
the CBN’s range of between 6 percent and 9 percent y/y, and presents a
challenge for the MPC when it next meets in July. “ The offering of
five, ten and 20-year paper is unchanged from the four previous months,”
said FBN Capital analysts.
“The offshore participation next week is
likely to be marginal, at best. The liquidity constraints forming the
basis of JP Morgan’s “threat” to delist Nigeria from its local currency
government bond indices are a powerful disincentive. The auction should
show the continuing appetite of the PFAs for the 20-year benchmark”, FBN
Capital analysts added.
United Capital analysts expect to see
mixed sentiment in the fixed income space this week. “We think
activities in the bond market will be stronger this week, though
expectation of higher rates in the primary market might spark
sell-offs,” United Capital analysts added.
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