Fixed income market… the growing concern

No doubt saying that year 2014 has been challenging for Nigeria. Particularly, with an increase in the intensity of Boko Haram terrorists’ attacks, a volatile and highly passionate political sphere, and the threat of a dangerous Ebola Virus Disease (EVD) outbreak, the country has faced considerable challenges in the last nine months.

These challenges, or its similarities, analysts believe have caused scepticism in Nigeria’s potential as an investment destination, like in other markets that have similar threats.

The bond market is not in isolation of these risks, particularly as elections draw near. Investors in Nigeria’s bond market are reducing their exposure to long-term instruments in fear of election risks.

While the monetary authorities anticipate threats to moderate prices and exchange rate stability to materialise from expansionary government spending due to a tough electoral cycle, investment advisors foresee likely increase in divestment of funds to political campaigns and the fear of post-election crises exerting pressure on some investors.

There was a lot of activity in the bond markets in the third quarter. The inclusion of the Federal Government 10-year bond on JP Morgan Index-Emerging market reignited the appetite of foreign investors, attracting offshore funds into the Nigerian bond market.

Last weekend, analysts noted that bargain hunters provided support for the yield curve, particularly on the short-end of the curve; as modest demand on bonds led to appreciable price gain. Overall, the yield curve eased an average of 15bps last Friday.

Notwithstanding, Friday’s rally, particularly in the bond market, analysts at Lagos-based Associated Discount House Limited, a major player in bond market, remain conservative, as they look forward to renewed sell-off this week, “as concern on fiscal revenue weakness dominates investor sentiment.”

“Is it a real recovery or ‘dead cat bounce?’ Justifying our call on the 13.05 percent FGN August 2016; the Note closed at N100.50/12.71 percent, gaining N0.25/16bps on the back of renewed investor appetite for short duration bonds,” the analysts said.

There are already concerns within the bond market that foreign portfolio outflow may intensify this week, as fears over naira devaluation heightens.

“The fixed income market witnessed sell-offs by foreign investors especially amid growing concerns of the potential risk of naira devaluation as the local unit continues to weaken against the dollar,” said market analysts at UBA Capital, another Lagos-based investment house.

Research analysts at CBO Capital, an advisory firm based in Lagos, said in their fourth-quarter (Q4) outlook that “foreign investors’ appetite for government bonds that has pushed yields down may begin to wane in response to the policy of central banks in developed economies.

“Outlook is cautious, as electioneering, and insurgency are expected to slow down investment activities even further. Retreat will hit borrowers hard and put pressure on local currency. However, the European Central Bank’s (ECB) recent decrease of policy rates may support global liquidity, which may see bond yields declining even further. Despite the conflict in the Middle East and Ukraine, oil prices continue to drop. This is counter intuitive, considering the roles Russia and Iraq play in global oil supply.”

CBO Capital analysts further stated: “It appears the United States’ drive towards energy self sufficiency will taper global oil supply-demand gap, ensuring global supply is insulated from shocks due to geopolitical conflicts. Once largest importer of Nigerian crude, the US records zero import from Nigeria.”

“Demand factors underpin FGN bonds, a shortage of alternatives for the locals and the still attractive returns for the offshore community. We see yields in a range of 12 percent to 13 percent in the quarter ahead,” according to analysts at FBN Capital, an investment arm of FBN Holdings plc.

These analysts said they see limited macroeconomic damage from the elections, notably a small increase in the fiscal deficit. “We are not pollsters but would not be surprised by the re-election of the incumbent. We expect that the new government will revive the flagging reform programme, and seek to tackle fuel subsidies and the PIB,” FBN Capital said in their recent report titled “the naira today’s issue, not the elections.”

Recent data from Central Bank of Nigeria (CBN) showed that July recorded the largest Foreign Portfolio Investment (FPI) flows into the bond market so far in 2014, with an increase of about 485 percent between June and July, from $84.59 million to $494.79 million and 102.85 percent increase compared with Q2 average of N243.91 million.

“The direction of yields in Q3, however, suggests inflows may have tapered off, with average yields rising marginally.

We expect liquidity in the financial system and foreign portfolio inflow to continue to be the major determinants of the direction of yields in the coming quarter.

With the 2015 general elections looming large over the country, we expect the fixed income market to attract renewed interest from portfolio investors, particularly at the short end of the curve, with yields moderating in response. We also expect asset substitution from the equity market to the fixed income market,” CBO Capital analysts noted in their economic outlook.

Iheanyi Nwachukwu