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Nigeria Strategy Report H2 2018 Excerpts - Nigeria Fixed Income: Have Yields hit the Bottom?

• Entering 2018, our prognosis for the naira yield curve was a continued downtrend over the year.  This view was hinged on the expectation that the intertwining effect of elevated liquidity profile and base effect induced downtrend in headline inflation will pave way for a loser monetary policy in H1 2018. True to our expectation, our views of a steeper naira yield curve played out as average fixed income yields dipped 100bps to 13.22% over the first half of 2018 on the back of sustained descent in inflation over H1 2018 and loser monetary policy via tapered liquidity mop up and cut in OMO rates. In terms of drivers, the decent in FI yields resonated FG’s drive to trim its cost of debt financing and CBN’s quest to keep OMO rates submerged in lockstep with plummeting headline inflation while keeping an eye on market liquidity to wade off currency attacks.
• Over the rest of the year, we expect activities of the monetary authorities to continue to influence the naira yield curve trajectory particularly at the short end. Specifically, the elevated liquidity profile over H2 2018 provides ample justification for a stay in MPR at current levels (14%) over H2 2018. Whilst on the fiscal side, FG’s borrowing pattern remains crucial in formulating an outlook. Having net repaid N49.7 billion over H1 2018, FG will need to borrow more over the rest of the year with our projections pointing to domestic borrowings of N437 billion in H2 18 and overall borrowings of N388 billion over 2018. Furthermore, on the external front, in addition to political uncertainty ahead of the general elections in 2019, the upbeat macroeconomic picture as well as drive towards interest rate normalization in the US amid rising inflation could further dampen foreign investors’ appetite for naira denominated paper. Over all, despite prospects for fairly robust local demand for FGN securities stemming from elevated liquidity, we expect the confluence of hawkish monetary policy, higher FGN paper supply and rising US treasury yields to drive rates a touch higher over H2 18.