FX Markets Liquidity Squeeze Keeps Naira Overvalued

FX Markets Liquidity Squeeze Keeps Naira Overvalued

Liquidity squeeze was experienced in the Foreign Exchange markets in April as Investors and Exporters window recorded significant daily turnover drop following a relatively dull outing in the month.

According to Chapel Hill Denham new report, liquidity nosedived in the Investors and Exporters Window as daily turnover fell by 11% to US$59.1 million as the Central Bank (CBN) failed to significantly step-up intervention sales in the window

The exchange rate continued to trade within a tight band at all segments of the FX market, according to currencies data recorded last week.

It was noted that in the Investors and Exporters window, the foreign exchange rate was unchanged on a week-on-week basis at N410.00 on Friday.

However, Chapel Hill Denham said intraday volatility remained high, as the pair went as high as N436.55 on some trading sessions, but closed within range of the de-facto peg of N409.00-N411.00 on all the trading days.

Also, analysts saw activity level declined at the investors’ and exporters window to a daily average of US$59.3 million, down 15% from US$69.9 million the previous week.

In the parallel market, Naira traded flat against the United States dollar at N485.00.

“The foreign exchange market was relatively dull in April, with barely any movement across all segments of the FX market”, Chapel Hill Denham stated.

Liquidity also nosedived in the Investors and Exporters Window with daily turnover falling by 11% to US$59.1 million, as the CBN failed to significantly step-up intervention sales in the window.

“Fundamentally, the Naira remains overvalued based on Reel Effective Exchange Rate (REER), trading nearly 20% above its long-run level”, analysts said.

FX Markets Liquidity Squeeze Keeps Naira Overvalued

Also, the investment firm stated that the adjustment process in the balance of payments is incomplete, as reflected in the wider trade deficit in Q4-2020, despite the previous currency devaluations.

“Our base case view remains that the regulator would have to engineer further adjustments in the NAFEX rate to resolve the liquidity challenges facing the market.

“The timing is uncertain, but may be drawing close, given the recent intra-day volatility of the dollar and naira pair”, Chapel Hill Denham reported.

In a related development, the Nigerian fixed income market last week recorded bearish trade as duration apathy led to further upward repricing of bond yields, while the bellwether 364-day Treasury bill auction stop rate cleared higher.

Front end rates traded mixed, with the open market operations (OMO) benchmark curve expanding by an average of 11 basis points (bps) week on week to 7.27%, while the T-Bill curve closed flat at an average of 4.23%.

In the bond market, yields surged by an average of 40 bps week on week across the benchmark curve to 12.80%.

Recall that at the rollover T-Bill auction which held last week, N88.5 billion was offered across three tenors: 91-day (N11.4 billion), 182-day (N6.0 billion), and 364-day (N71.1 billion) bills.

Analysts said despite the weak liquidity in the financial system, the subscription level was decent N242.9 billion, implying a bid-cover ratio of 2.7x, down from 3.6x at the previous auction.

The CBN over-allotted in order to frontload issuances, selling a total of N129.5 billion split as follows: N7.2 billion of 91-day, N6.0 billion of 182-day, and N116.3 billion of 364-day.

The stop rate on the 364-day cleared higher by 75bps to 9.75%, while the 91-day and 182-day rates were unchanged at 2.0% and 3.5% respectively.

Chapel Hill Denham also explained that the bear run in Nigeria’s local currency (LCY) bond market entered its fifth month in April, as yields continued to reprice higher from record levels in November 2020.

On an aggregate basis, measured by the S&P FMDQ Nigeria Bond Index, Nigerian sovereign LCY bonds lost 8.3% in April, as yields expanded by an average of 238bps across benchmark tenors.

“May promises to be an eventful month for the fixed income market, with major data publications and events ahead, which are expected to shape sentiments”, Chapel Hill Denham hinted.

On the data front, April consumers’ price index (CPI) data is projected to record further uptick in headline inflation rate to 18.7% from 18.2% in March.

National Bureau of Statistics reported 18.17% headline inflation rate for Month of March after 19 consecutive monthly uptrend.

“We expect the Q1-2021 GDP data to show a consolidation of the growth recovery with a 0.4% year on year expansion.

“We believe that the elevated inflation environment and further recovery in economic activities will set the stage for a hawkish MPC meeting later in the month, with committee members likely to vote for a 50bps MPR hike to 12%”, analysts added.

In the money market, liquidity conditions are expected remain constrained, with only N260 billion OMO maturities and scanty bond coupons expected in the month, analysts said.

The investment firm said the constrained interbank liquidity and likelihood of MPC rate hike, will likely culminate in further bearish sentiments in the bond market, even as yields are now looking attractive at current level.

“This week, interbank funding pressures will likely persist due to paltry OMO maturity (N20 billion) on Tuesday”, Chapel Hill Denham said.

FX Markets Liquidity Squeeze Keeps Naira Overvalued