Fixed Income Valuations Stretched as Inflation Rate Rises Unabated
Fixed income valuations are obviously stretched at current level, based on fiscal and external balance, as well as inflation expectation, analysts at Chapel Hill Denham have hinted.
Yields on debt instruments have been spiraling downward, nearing zero amidst strong financial system liquidity.
Unfortunately, inflation rate has spiked further, printed at 14.23% for October, 2020 while a slew of research analysts have started tracking higher reading for the year.
Yet, analysts stated that the liquidity glut, which has supported the fixed income rally will likely persist until March 2021, before open market operations (OMO) maturities drop off substantially in April 2021.
Nonetheless, Chapel Hill Denham believes that the market should be able to comfortably absorb the relatively weak supply of government securities in the absence of OMO issuances, with net domestic issuance in the proposed 2021 federal budget pegged at N2.1 trillion.
“In our view, an aggressive tightening of monetary policy will be required to rebalance the market”, Chapel Hill Denham stated.
Analysts explained that the apex bank has built up considerable excess bank reserves worth N11.3 trillion in August 2020, up 2.1x year on year via arbitrary Cash Reserve Requirement (CRR) debits.
However, experts believe this could be freed up at any time if liquidity becomes too tight, thus representing a downside risk to yields.
On the other hand, Chapel Hill Denham position is that the CBN could eventually concede the point that its dovish monetary policy bias is a risk to macroeconomic stability.
At that point, the market is likely to see an aggressive tightening of monetary policy, thus representing an upside risk to yields.
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Amidst this uncertainty, analysts at Chapel Hill Denham said they expect the yield curve to remain steep, with the dovish monetary policy keeping short term rates subdued, while term premiums remain high due to monetary policy risk.
Fixed Income Valuations Stretched as Inflation Rate Rises Unabated
