Last week we saw a steep rise in banks' deposit rates and short-dated Treasury Bill (T-bill) rates. Was this the much-awaited transmission of rates after the CBN raised the Monetary Policy Rate (MPR) from 11.50% to 13.00% on 24 May? Or was it down to short-term money market conditions? It appears to have been the latter, but the CBN appears to be tolerating a gradual rise in 1-year T-bill rates, which is good news for savers.

New Hope for Savings Rates

A month ago, in our report, Why are savings rates rising so slowly? (14 June 22), we questioned the transmission mechanism between official and market rates following the 150bps hike in the Monetary Policy Rate (MPR) to 13.0% by the CBN on 24 May. Since then, short-term T-bill yields have risen sharply. Is this a delayed reaction to the MPR hike, or is something else at play?

A month ago, T-bills yielded 4.13% on average in the secondary market. At the end of last week, the average yield was 6.81%, implying a 268bps jump. Specifically, the 1-year T-bill yield rose by 133bps to 6.39%. We also saw the 1-year yield rising to 6.46% at the primary auction, and investors sold off in the secondary market, driving the yield upwards towards its primary market counterpart. 

However, the major drivers of the overall T-bill yield last week were the shortest end of the curve. Specifically, yields on the 3- month (+602bps) and 6-month (+446bps) T-bills have risen significantly to 9.50% and 8.62%, respectively. As a result, part of the yield curve is now inverted as 3- and 6-month yields are higher than 1-year yields.

The reason for the inversion is a sustained squeeze in banking system liquidity, in our view. In recent weeks, outflows from the system such as the Cash Reserve Requirement (CRR), Open Market Operations (OMO), T-bill and FGN bond auction debits have outweighed inflows from sources such as Federation Account allocations to states and local governments, T-bill and OMO maturities, and FGN bond coupons. The immediate reaction of the banks last week was to raise their deposit rates; they also sold off short-term liquid instruments such as CBN Special Bills and short-dated T-bills, leading to the rapid increase in yields.

Historically, this has tended to be a temporary occurrence and this instance is unlikely to be different. As a result, we expect banks' deposit rates to moderate soon and a correction at the short end of the yield curve once system liquidity returns to a surplus position. 

However, it does seem that the CBN is tolerating a gradual rise in 1-year T-bill rates as these have been rising since mid-March when they were just under 4.00%. Further along the curve, our core view remains that a rise in the government deficit is likely to lead to an increase in Naira-denominated government borrowing this year, with the implication that market interest rates will rise.

FX

Last week, the exchange rate at the Investors and Exporters Window (I&E Window) weakened by 0.27% to N426.13/US$1, its lowest level since end-December 2021. Elsewhere, the foreign exchange (FX) reserves of the Central Bank of Nigeria (CBN) increased by 0.44% to US$39.34bn, the highest level since 5 May, enhancing the ability of the CBN to continue interventions across the various FX windows. Oil prices and production are now giving visible support to the FX reserves of the CBN whose confidence in being able to defend the current I&E Window rate, or something very close to it, must have risen. We expect these rates to persist for several months at least.

Bonds & T-bills

Last week, trading in the Federal Government of Nigeria (FGN) bond secondary market remained bearish as tight system liquidity persists. Consequently, the average benchmark bond yield rose by 11bps to close at 11.29%. Notably, the yield on the 7-year (+2bps to 10.95%) and the 10-year (+2bps to 11.71%) bonds expanded, while the yield on the 3-year (- 3bps to 10.04%) bond declined. Our view remains that the combination of thin system liquidity and elevated Federal Government domestic borrowing is likely to sustain the rise in bond yields over the coming months. 

Activity in the Treasury Bill (T-Bill) secondary market was also bearish as the average yield rose by 142bps to 6.81%. Additionally, the yield on the 335-day T-bill gained 20bps to close at 6.39%. At the primary auction, the Debt Management Office (DMO) is expected to offer N143.27bn in T-bills to the market. Elsewhere, the average yield for OMO bills rose by 98bps to 6.32%, while the yield on the 298-day OMO bill fell by 1bp to close at 6.81%.

Oil

Last week, the price of Brent fell to as low as US$100.69/bbl, its lowest level since 7 April, before settling at US$107.02/bbl. The 4.13% w/w drop marked Brent’s second successive weekly loss and the most in the three weeks. Nonetheless, Brent is up 37.59% year-to-date and has traded at an average of US$105.05/bbl, 48.19% higher than the average of US$70.89/bbl in 2021. 

It was another week of significant volatility for oil prices, with recession fears taking centre stage. The mid-week loss of 9% marked the third biggest single-day decline since Brent crude started trading in 1988. By the end of the week prices rebounded slightly as the market returned its gaze to the extremely tight supply picture. 

The US government announced another round of sanctions on several Chinese and other firms that allegedly deal with Iranian crude, following a breakdown in talks over reviving the Joint Comprehensive Plan of Action (JCPOA) i.e. the Iran deal. Our view remains that Brent is likely to stay above the US$60.00/bbl mark for several more months and well above the US$73.00/bbl benchmark in the government’s 2022 budget.

Equities

Last week, the NGX All-Share Index fell by 0.53%, the most in three weeks, to settle at 51,557.41 points. Consequently, its year-to-date return fell to 20.70%. International Breweries (-14.29%), MRS Oil Nigeria (-11.08%) and FBN Holdings (-8.62%) closed negative, while Honeywell Flour Mills (+7.61%), Cadbury Nigeria (+4.91%) and United Bank for Africa (+2.03%) closed positive. Performances across the NGX sub-indices were broadly negative, with the NGX Insurance index (-2.53%) declining the most, followed by the NGX Consumer Goods (-1.42%), NGX Pension (-0.94%), NGX-30 (-0.53%), NGX Oil & Gas (-0.41%), NGX Banking (-0.31%) and NGX Industrial Goods (-0.15%) indices

Model Equity Portfolio

Last week the Model Equity Portfolio fell by 0.13% compared with a fall in the NGX Exchange All-Share Index (NGX-ASI) of 0.53%, outperforming it by 39 basis points. So far this year it has gained 23.58% against a 20.70% gain in the NGX-ASI, outperforming it by 288bps. 

Last week, our largest loss came from our one-third underweight notional position in BUA Foods which cost us 13bps, followed by our very underweight notional position in FBN Holdings which cost us 3bps and our very underweight notional position in Nigerian Breweries which cost us 2bps. There were some gains, notably in our notional position in UBA which earned us 4bps and MTN Nigeria which earned us 2bps, while Zenith Bank earned us 1bp. 

Since the beginning of June, we have been reducing our positions in mid-cap stocks (such as Nigerian Breweries) which had earlier rallied hard. These tactics paid off last week as we lost less than we would have done with a neutral position. The story is similar with FBN Holdings, though here we have been reducing our notional position over the past six months, beginning the year with a 1.8% notional position and now with a 0.3% notional position (versus an index weight for the stock of 1.4%).

We wrote last week that markets never trend sideways for long, though the NGX All-Share Index has been trying to prove us wrong over the past few weeks. It is down just 0.76% since the Monetary Policy Committee of the CBN raised in its Monetary Policy Rate from 11.50% to 13.00% on 24 May. We have benefited by avoiding over-exposure to several mid-cap stocks when they corrected, and our high cash position stood us in good stead as the market pulled back slightly after the first week of June. However, our cash position is very defensive and now we must decide how to position ourselves going forward. 

There are two things to consider. First, is it likely that any of the largest stocks by market capitalisation (Airtel Africa, MTN Nigeria, Dangote Cement, BUA Cement, Nestle Nigeria and BUA Foods, which together make up 73% of the index) will surprise on the upside when they report Q2 results in a few weeks? We think that there is potential for MTN Nigeria and Dangote Cement to do this. We are actually slightly underweight in these stocks at the moment so will make notional trades with the aim of making them 200bps overweight each this week. 

Second, international palm oil prices are moving downwards. More than half our outperformance (172bps of the total 288bps) this year has come from our positions in two palm-related stocks, Okomu Oil and Presco. There is an argument to be had that their Q2 results themselves will support the stocks even if base prices are sliding, but we are not inclined to test it and will start to make notional sales in the direction of neutral weights in either stock going forward, liquidity permitting. 

In addition, there is the question of whether we should also re-balance in favour of the mid-cap stocks that performed well earlier in the year and that have since corrected? Could their Q2 results make them rally again? We will consider this question next week.