Sub-optimal Demand at DMO’s Latest Bond Auction

The DMO held its monthly auction of FGN bonds on Monday. It offered N225bn but raised N123.9bn (USD288.7m) through re-openings of the 2025, 2032 and 2042 FGN bonds.

Demand was considerably lower, as the DMO secured a total bid of N142.3bn (USD331.6m). The bids for the 3, 10 and 20-year benchmarks were allotted at the marginal rates of 11.0% (previously; 10.1%), 13.0% (previously; 12.5%) and 13.7% (previously; 13.2%) respectively. The DMO has a domestic funding target of N3.53trn to finance the projected deficit of N7.35trn in the FGN’s 2022 budget.

The relatively lower demand at the auction is reflective of tight system liquidity which can be partly attributed to CBN’s continuous use of the discretionary Cash Reserve Ratio (CRR) debits.

According to the MPC/CBN, the use of discretionary CRR debits are vital in controlling excess liquidity. We note that system liquidity stood at -N169.5bn as at 18 July ‘22.

Investors’ apathy towards the current level of FGN bond yields is another reason for weaker demand. The domestic fixed income market is currently dominated by local investors and real interest rates have remained negative. The headline inflation stood at 18.60% y/y in June ‘22. This is the highest headline inflation rate since January ‘17.

At its latest meeting held yesterday, the monetary policy committee raised the monetary policy rate (MPR) from 13% to 14%. The committee expects this additional tightening to assist with moderating rising inflation and narrow the real interest rate gap.

For Q3, the DMO plans to raise between N630bn – N720bn through FGN bonds. The debt management office had set out to raise between N1.7trn – N1.9trn by end-Q3 ’22.

However, year-to-date, it has raised N1.9trn. Therefore, the DMO is likely to exceed its borrowing target for FGN bonds by end -Q3 ’22. Allowing for the smaller amounts which the FGN raises from the sale of other debt instruments such as NTBs and savings bonds, it is on track pro rata to meet the domestic borrowing target for the year.

In the secondary market for FGN bonds, YTD the average yield has declined by 8bps. In the near term, we expect yields to trend upward on the back of increased supply by the FGN. On a separate note, the international debt market is now more expensive for emerging economies like Nigeria amid monetary policy tightening by advanced economies.

We see mid-curve FGN bond yields around 11.5% – 12.7% and yields at the longer-end of the curve between 12.5% – 13.7% over the next one month. However, the level of liquidity (influenced by items such as auctions, CRR debits/refunds, bond/NTB maturities, coupon payments and FAAC allocation) would also impact the movement in yields.