The Strange Yield Curve
- By Coronation Research
Since the beginning of the year fixed income yields have been rising. Yet the movement in rates has been unequal across durations. Long-term bond rates have risen sharply and so too have 1-year T-bill rates at auction. But short-term T-bill rates have stayed low.
Last week the exchange rate in the Investors and Exporters Window (I&E Window) strengthened by 0.24% to close at N410.00/US$1. In the parallel, or street market, the Naira weakened by 0.62% to close at N485.00/US$1. The gap between the two markets is 18%. There was slight, 0.08%, fall in the level of the CBN’s FX reserves to US$35.12bn, though this level appears quite reassuring to the market, especially in the context of the ability of the Federal Republic of Nigeria (FGN) to make a substantial Eurobond issue, which it intends to do. There is not the sense urgency now that existed in February, when the I&E Window rate last shifted in the direction of the parallel rate. But without such shifts we doubt that liquidity in the I&E Window and NAFEX markets will pick up meaningfully. Over a period of months, we believe that there will be continued pressure on the I&E and NAFEX rates
Bonds & T-bills
Last week, the secondary market yield for a FGN Naira-denominated bond with 10 years to maturity rose by 53bps to 12.70% and at 7 years rose by 26bps to 12.43% while at 3 years the yield contracted by 3bps to 9.92%. Activity in the market was typically low given that the FGN bond auction took centre stage. After the auction bearish sentiment was characteristic. Given market sentiment, our sense is that the bear run in bonds is likely to continue for a while.
The Debt Management Office (DMO) offered for subscription FGN bonds on 21 April 2021, reopening the March 2027, March 2035, and July 2045 issues. A total of N265.68bn (US$648.05m) worth of bonds were bid for against N150bn (US$365.85m) offered and N157.95bn (US$385.24m) worth of bonds were allotted.
The annualized yield on a 342-day T-bill fell by 1bp to 8.06%, and the yield on a 326-day OMO bill declined by 2bps to 9.12%. The CBN’s OMO auction of N20.00bn managed to sell N12.84bn of the total offer and had stop rates for the 96-day note at 6.90%, 187- day note at 8.48% & 355-day note at 10.10%. We expect a T-bill auction on Wednesday this week and, given the steady upward movement in 1-year T-bill stop rates, it wouldn’t surprise us to see 1-year yields reach or even pass 10.00% though, based on experience so far this year, yields on short-dated paper may not increase.
The price of Brent crude dropped by 0.99% last week, closing at US$66.11/bbl, a 27.63% increase year-to-date. The average price to year-to-date is US$62.02/bbl, 43.52% higher than the average of US$43.22/bblin 2020. News early in the week about the continued increase of Covid-19 cases in India and Japan were offset by bullish economic data from the US and Europe. Later this week the Organization of the Petroleum Exporting Countries and its ally Russia (OPEC+) meet, and their decision on the duration of current production cuts is likely to influence the market strongly. In general, OPEC+ appears to have shifted its position on the ideal level of prices, with prices well above US$60.00/bblnot causing disagreements (even though this encourages US shale production). Our sense is that prices remain supported at US$60.00/bblover the coming weeks
The Nigerian Stock Exchange All-Share Index (NSE-ASI) rose by 1.27% last week bringing the loss year to date to 2.41%. PZ Cussons +21.11%, Honeywell Flour Mills +17.65%, and Sterling Bank +8.78% closed positive last week, while Guinness Nigeria – 9.89%, Fidelity Bank -7.08%, and Cadbury Nigeria -3.70% closed negative. Performance across sectors was broadly positive as the NSE-Industrial index was the highest gainer for the week with +4.82% while NSE-30 advanced by +1.64%, NSE Consumer Goods by +1.05%, NSE Insurance by +0.40% , and NSE Oil & Gas by +0.29%.
The Strange Yield Curve
The past month has seen a rout in the bond market, with prices of Federal Government of Nigeria (FGN) bonds falling heavily. The average yield of 10 FGN bonds which we track, with durations of between two and 15 years, has increased by 216 basis points (bps) over the past month, and by 561bps since the beginning of the year. This is bad news if you are required to mark bond positions to their market price, but good news if you are considering a future purchase of a bond, although it has to be said that, so far, no FGN bond yield comes close to matching the rate of inflation at 18.17% year-on-year (in March).
What about Nigerian Treasury Bills (T-bills), with duration of up to one year? Most of the action takes place in the Debt Management Office’s Primary Market Auctions (PMA), which are held two or three times per month. Here the rates on 1-year (or 364-day) paper have been moving up at successive auctions, with rates actually matching those of 2-yr FGN bonds.
However, while the rates on 364-day T-bills in the PMA have been moving up, those on 91-day and 182-day T-bills have stagnated since the of February. In part this is due to the fact that the short-term market is seen as separate from the 364-day market and the FGN bond market. And there are some profound effects.
One is that it is difficult for Money Market Funds, which constitute the largest class of Mutual Fund (or Collective Investment Scheme) to generate yields close to 364-day yields, given that they must hold a proportion of their funds under management in short-term money market investments. Retail savers who access the market through Money Market Funds are not getting the full benefit of rising rates, so far.
Naturally, this is good news for banks, since the fundamental business of banking is to take short-term liabilities (mainly deposits) and to create, or buy, long-term investments. To have such a large gap between 91-day and 182-day T-bills on the one hand and 364-days T-bills on the other is helpful. Preferred clients can be offered deposit rates well above short-term money market rates.
The question arises as to how long this situation can last. The paradox of this year’s rise in market interest rates is that it is taking place while there is still quite a lot of institutional and corporate liquidity around, so it does not seem likely that liquidity conditions will force up short-term rates soon. Therefore, this situation may last a while yet.
Model Equity Portfolio
Last week the Model Equity Portfolio rose by 1.46% compared with a rise in the Nigerian Stock Exchange All-Share Index (NSE-ASI) of 1.27%, therefore outperforming it by 19 basis points. Year to date it has lost 1.17% against a loss in the NSE-ASI of 2.41%, outperforming it by 124bps.
Maintaining our conviction in Stanbic IBTC paid off as our notional overweight position (5.0% versus the index weight of 2.7%) delivered 41bps. (This notional position caused us some concerns a few weeks ago, but we stuck with it.) Our notional overweight position in GT Bank (7.9% versus the index weight of 4.8%) delivered 53bps. Our newly neutral notional position in MTN Nigeria (we spent the weeks of the 26 March and 6 April restoring it from an underweight to a neutral, as we forewarned before the Easter break) earned 22bps.
What do we do now? We will deploy a little more of our cash into our bank positions, reducing our notional cash position by between two and three percentage points this week. We will look for opportunities among the insurance stocks and report back.