Treasury Bill: We think Yields Can Reach 10% by Mid-year –Coronation

Treasury Bill: We Think Yields Can Reach 10% By Mid-Year –Coronation

A leading investment firm, Coronation Asset Management Limited, has predicted that yields on Nigerian Treasury bill could rise to 10% or even more by mid-year 2021.

The research unit of the asset management firm stated this in a new report.

Coronation said recent auctions in the Nigerian Treasury Bill (T-bill) market have reached yields of 5.5% for 1-year paper, trending upwards and trading much higher than yields in the secondary market.

“We think that T-bill yields can reach 10.0% per annum, if not higher, by mid-year”, investment experts at the firm noted in the report.

It added that there is also a complex connection with rising US dollar bond yields.

Last week, the secondary market yield for an Federal Government of Nigeria’s Naira bond with 10 years to maturity declined by 2 basis points (bps) to 10.77% and 7-years declined by 12bps to 10.33% while at 3-years the yield declined by 110bps to 6.84%, making the yield curve steeper.

“What has happened is that long-dated FGN bonds have been selling off while maturities of 5-years and under are being bought”, the report stated.

It noted that the annualized yield on a 335-day T-bill remained unchanged at 2.07% in the secondary market.

Meanwhile the yield on a 333-day open market operation (OMO) bill of the CBN declined by 64bps to 8.96%.

At last week’s Primary Market Auction for T-bills, on the other hand, the stop rates closed higher by about 133bps on average across the three tenors, closing at 2.00%, 3.50%, and 5.50% for the 91-, 182- and 364-day offers respectively.

“Although there is noticeable rotation in the bond market from long-dated to short-dated maturities, we believe that the overall trend in rates is upwards and will remain so for at least several weeks.

“Yields in the Nigerian Treasury Bill (T-bill) market are rising and last week we received several clues as to their future direction”, the firm stated.

It expressed observation that in recent weeks trading has focused on the primary market auctions.

Last week a T-bill with 364 days to maturity was sold at 5.5%: two weeks prior that it had sold at 4.0%.

“If we are correct in thinking that the primary auctions accurately reflect supply and demand (more so than the secondary market) then it follows that investors are pushing rates up.

“It also suggests that the Debt Management Office (DMO) and the Central Bank of Nigeria (CBN) tolerate these developments”, Coronation said.

It noted the CBN issued open market operation (OMO) bills in February at just over 10.0% per annum.

The asset management firm said these sales are only available to foreign investors and Nigerian banks. OMO bill yields, therefore, do not translate into the secondary market for T-bills where pension funds, insurance companies, mutual funds and others are active.

“However, as we argued on these pages two weeks ago, the CBN may be sending a signal to all the fixed income markets with its OMO rates”, it added.

Experts at the firm said one solid argument for allowing rates to rise is that Nigeria’s T-bill yields are out of step with interest rates in other nations, which inhibits foreign portfolio investment (FPI) reaching Naira-denominated securities.

“When international investors look at local currency yields, they usually compare yields with local inflation, with a simple inflation adjustment (1-yr risk-free rate minus inflation) being a sufficient guide (which is often seen as a proxy for upcoming devaluation).

“On this comparison Sub-Saharan African countries like Ghana and Kenya score well and so too, to some degree, does South Africa.

“Large nations like Brazil, Russia, India and China currently have 1-year risk-free rates close to inflation.

“Nigeria is a significant outlier. When it comes to inflation, interest rates are a contributory factor”, Coronation explained.

It added that other key factors include effective exchange rates; external input prices (notably the price oil as reflected in petrol and diesel prices); structural factors (in other words, efficiency); money supply (including financing of government).

Clearly, it is difficult for policy makers in any country to address all these variables at the same time, the firm said.

However, Coronation thinks interest rates can be addressed quite straightforwardly.

“When headline inflation increases from 15.75% year on year in December to 16.47% in January, then the case for allowing market interest rates to rise is easy to make”, the firm posited.

How does this square with what the CBN is saying?

“We are fortunate in that the Governor of the CBN, Godwin Emefiele, made his opinions clear in an address to the Vanguard Economic Summit last week (Thursday 16 February) organised by the Vanguard Newspaper.

“He voiced his concerns that: “the economy still remains on a fragile recovery path. It is therefore imperative that we do all we can in 2021 to ensure that we build on the positive momentum and strengthen our efforts at stimulating growth.”

The answers to the question of how to keep the economy growing include measures to sustain the accommodative fiscal and monetary policy measures aimed at improving access to finance to households and businesses, and improving Foreign Exchange inflows into the country.”

The asset management firm asked if accommodative fiscal and monetary policy measures necessarily mean a continuation of 2020’s policies of low interest rates.

“We do not think so. Accommodative fiscal policy can mean helping government to reach its budget targets, which does not have a direct bearing on interest rates.

“Accommodative monetary policy measures do not necessarily imply low interest rates, especially when one considers that the CBN makes a priority of targeted lending to strategic sectors such as agriculture in its efforts to support the economy.

“These can be considered accommodative measures, not just market interest rates.

“And allowing market interest rates to rise squares with the Governor’s stated desire to improve foreign exchange inflows”, Coronation explained.

Furthermore, the firm noted that it is not often that the US bond market appears to have an influence on Nigerian rates.

It said they are usually quite separate.

“Yet we cannot help noticing that US 10-year bond yields are rising just at the same time as Nigerian Naira 1-yields are rising”.

“Note that we are talking about 1-year Naira yields and 10-year US bond yields: short-term rates in the US are still trending downwards”

The asset management firm said the narrative behind the rise in US 10-year bond yields comes from the US decision to introduce an enormous fiscal package to stimulate the economy.

“This implies that economic growth will pick up; some models link rates directly to growth; in any case, growth could imply rising inflation in which case the US Federal Reserve system would be obliged to raise rates at some point in future.

“The narrative in Nigeria is somewhat different”, Coronation explained in the report.

Experts noted that inflation is already rising even though growth is slow (the economy grew by 0.11% in Q4 2020).

As such, it believes interest rates needs to rise if these will help contain inflation, noting that attractive interest rates are needed for foreign investment.

So, the firm said the similarities between the two markets are not obvious. Having said that, it explained that the rise in US 10-year government bond rates is having some significant effects.

“The advance in commodity prices has paused; the US Nasdaq market of technology stocks corrected by 6.9% in the second half of February; the yields of emerging market sovereign Eurobonds have begun to rise, after 10 months of relentless yield compression.

“This year began with the ‘global hunt for US dollar yield ‘ thesis intact: now it has a question mark over it.

“For the issuer and for the holders of Nigerian sovereign Eurobonds it is important to consider the implications”, Coronation Asset Management said.

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Treasury Bill: We think Yields Can Reach 10% by Mid-year –Coronation