Some holders of Nigerian government bonds are torn between selling now and making good profit or holding out in the coming months and making an even juicier return.
Nigerian bonds are currently trading at a premium to par, as a supply cut back by the government has sent yields to a near three-year low.
The question however is if there is still some room for yields to fall.
“Everyone (bond holders) is looking for triggers to sell, but are having a hard time guessing whether rates have bottomed or if there is still some way to go,” an institutional bondholder who craved anonymity told BusinessDay.
“It is difficult to find news that will trigger a sell-off these days,” the person added, pointing to declining inflation and waning bond supply by the government.
The right bet on the direction of yields would return bumper gains for bond holders, largely Pension Funds Administrators- as they hold the single largest share of federal government bonds at 55.7 percent of their total assets. That comes to N4.1 trillion.
A BusinessDay survey on five fixed income analysts suggests that yields will tumble further.
“There is still room for a 50 basis points moderation in yields between now and the third quarter,” said Abiola Rasaq, head of investor relations at tier-one lender, United Bank for Africa.
He points to declining inflation, stable exchange rate and reduced government borrowing in the domestic market as factors that support his outlook for further yield moderation in the coming months.
“However, as presidential elections in 2019 draw close, the risks to that outlook include an unlikely rate hike by monetary authorities to manage the inflationary pressures of electioneering and tame portfolio outflows associated with an election year,” Rasaq said from Lagos.
Average bond yields are currently near three-year lows of 12.85 percent, levels last seen in April 2016 when the monetary policy rate was at 12 percent.
The yield on the benchmark 10-year bond maturing in November 2018 cooled 200 basis points to 13 percent and was priced at 111 at the secondary market on Tuesday, April 25, according to FMDQ data.
When a bond is priced above 100, it is said to be trading at a premium, helping bond holders, who bought when yields were as high as 18 percent, to book bumper gains if they sell in the secondary market.
The rally in bond prices has been triggered partly by falling inflation.
Annual inflation fell to 13.34 percent in the month of March, the 14th straight month of decline since peaking at an 11-year high of 18 percent in 2016.
It was the first time since 2015 that inflation rate fell below the benchmark lending rate of (14 percent).
Asides declining inflation, another factor that has given rise to bond bulls are indications that the Federal government is bent on reducing domestic borrowing to manage ballooning debt servicing costs.
The second quarter bond issuance calendar shows the government is looking to raise about N270 billion in 5, 7 and 10-yr bonds, much less than was raised last year.
“That’s half the amount raised in the same period of last year and would leave investors with excess cash, mounting further pressure on yields,” said Wale Okunrinboye, a fixed income analyst.
“There is still room for yields to decline to as low as 11 percent,” Okunrinboye added.
The Bond market has remained significantly bullish with yields compressing by another 20bps, consequently capping a c.70bps decline in yields for the third consecutive session since the last OMO auction, last Thursday by the CBN.
“If interest rates continue to contract and the government sustains its policy of reflating the economy by cutting back on domestic debt, yields will moderate further,” said Johnson Chukwu, CEO of Lagos-based financial advisory firm, Cowry Assets.
Bond traders have had a hard time guessing if improving inflationary conditions, a somewhat stable naira exchange rate and the government’s reduced appetite for domestic borrowing are enough to drive yields downwards this year.
Decelerating inflation and exchange rate stability make a compelling case for the CBN to reduce OMO auctions- which the apex bank frequently used to defend the naira exchange rate and tame rising inflation in thick of an economic crisis in 2016.
The OMO auctions ensured there was not too much naira chasing scarce dollars at a time when low oil prices and production as well as a slide in foreign investment had taken its toll on dollar liquidity and forced a near 40 percent naira devaluation.
Petrodollars are flowing again with the rise in global oil prices and domestic production as well as improved foreign investments which have been lifted in no small way by the creation of a market-determined foreign exchange window (called Nafex) in April 2017, yet the CBN has another reason to continue its OMO auctions.
That reason is the need to create a floor for interest rates to ensure they do not become too low and less attractive for portfolio investors.
Portfolio inflows accounted for 60 percent of total dollar flows in 2017, indicating its significance to the economy.
Propelled by a 304 percent surge in portfolio inflows to $7.3 billion compared to the previous year ($1.8 billion), total capital imported into Nigeria more than doubled to a 3-year high of $12.2 billion last year from $5.1 billion in 2016, according to data from the National Bureau of Statistics.
“The CBN is very mindful of foreign portfolio inflows and if they halt OMO issuances today rates could collapse to single digits and that may trigger some outflows,” a bond trader told BusinessDay.
But this could also lead to instability in the exchange rate, a situation that the CBN would want to avoid.
LOLADE AKINMURELE
