In a global oil market threatened with over-supply, it appears that OPEC, and its ally Russia, are doing a good job of limiting production. Oil price volatility was reduced in 2019 and prices (Brent) held up above US$60.00/bbl most of the time. With further OPEC cuts announced last December, we think 2020 may well be a repeat performance. The current futures curve supports this view. We look for oil to average at least US$60.00/bbl this year.
We expect that the CBN will keep the exchange rate at close to N362.50/US$1 for most, if not all, of 2020. Although foreign exchange reserves fell steeply during the second half of 2019, we believe there will be sufficient sources of US dollars in 2020 for the CBN to support FX reserves. These include possible issues of eurobonds and international loans. Important data points, in this regard, will be the level of foreign portfolio investment (FPI) in the CBN’s open market operation (OMO) bills during January and February 2020. If this resumes in earnest then the pressure on FX reserves will ease considerably, in our view.
We expect downward pressure on T-bill and government bond rates to continue as domestic funds rotate from high-yielding CBN OMO bills into government securities. However, there are two disruptive forces at work, we believe, which could change the interest rate outlook.
Possible change in interest rate regime
First, it is not certain that foreign portfolio investors will return to buy the CBN’s OMO bills in early 2020. Second, Naira T-bill yields are close to yields on Nigeria’s sovereign US dollar eurobonds, so demand for US dollars may increase. If FX reserves fall quickly (for example, as fast as they did during H2 2019), we could see a reversal of interest rate policy, opening the way for T-bill rates to rise.
Bank stocks, and earnings
This time last year we argued that bank valuations were low but that a catalyst was required. This year we cannot complain about the catalyst. T-bill yields have fallen far below, in some cases half the level of, the gross dividend yields of several listed banks. Hence our continued Buy recommendations. Bank earnings may suffer somewhat from the CBN’s initiative to limit the scope of card charges: but this will likely be offset by balance sheet expansion and a degree of interest rate protection from high-yielding securities, in our view.