CBN rate cut puts pressure on fixed income yields

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The Central Bank of Nigeria’s decision to cut its benchmark interest rate to 23 per cent is expected to put further downward pressure on yields across the fixed income market as investors adjust to a lower interest rate environment.

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The Monetary Policy Committee cut the Monetary Policy Rate by 350 basis points from 26.5 per cent at its 307th meeting in Abuja on Tuesday.

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The decision came against a backdrop of moderating inflation. Headline inflation fell to 15.39 per cent in August from 15.43 per cent in July, while food inflation declined to 19.57 per cent from 20.31 per cent. Month-on-month headline inflation also slowed to 0.71 per cent from 1.57 per cent.

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Fixed income yields had already begun declining before the MPC decision.

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At its latest Open Market Operations auction, the CBN offered N1tn of bills, attracting N6.31tn in subscriptions and allotting about N4.4tn.

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The 154-day OMO bill cleared at 18.41 per cent, while demand for the instrument reached N4.2tn against an offer of N400bn.

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Its true yield was 19.96 per cent, down from 20.64 per cent at the previous auction.

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The reduction in the MPR could reinforce the downward repricing of fixed income securities as investors adjust their return expectations to a lower policy rate environment.

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Treasury bills and OMO bills are likely to feel the impact first because their yields are more closely linked to short-term liquidity conditions and monetary policy.

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A sustained decline in short-term yields could also feed into the bond market, although the adjustment may be slower and depend on inflation expectations, liquidity and government borrowing needs.

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For investors, falling market yields have different implications depending on when the securities were purchased.

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Investors holding existing fixed income securities, particularly longer-duration bonds, could benefit from price appreciation if market yields decline further. This is because existing securities with higher coupons become more attractive relative to newly issued securities carrying lower yields, analysts say.

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However, investors deploying fresh funds could face lower returns if new Treasury bills, OMO bills and bonds are issued at lower rates.

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“If Treasury bill and OMO yields decline further, investors seeking higher returns may increase their allocation to equities, corporate debt and longer-dated securities,” said an Abuja-based economist, Chukwunonso Iheoma.

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“Investors who depend on short-term government securities for income could see returns fall as new instruments are issued at lower rates.

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“Holders of existing longer-duration bonds could benefit from price appreciation if market yields continue to decline.”

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The Federal Government could also benefit if the decline in domestic yields is sustained.

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Lower yields could reduce the cost of refinancing maturing domestic securities and make new domestic borrowing cheaper, Iheoma said.

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However, the impact on the government’s overall debt-service burden would take time because a large portion of existing debt was issued under previous interest-rate conditions.

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“The more immediate effect is likely to be visible in newly issued Treasury bills, OMO bills and other fixed-income instruments priced at prevailing market rates,” said a Lagos-based fixed-income analyst, Temitope Oduola.

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“The financial markets are likely to respond first through lower short-term yields.”

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