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Egypt Economics - Easing cycle is just round the corner

With real rate in positive territory, CBE has room to cut rates

Inflation has been seeing notable moderation over the past few months, with January’s inflation numbers further confirming that. Food inflation contracted, for the third consecutive month, while non-food inflation was up only 0.2% M-o-M, having been flat in December. Moreover, nine of the 12 components of the consumer basked have seen stagnant inflation in January. This clearly suggests inflation has notably moderated, on a seasonally adjusted basis, in the past few months, with such moderation clearly reflecting more than just a favourable base effect. This was a pre-condition for the easing policy set by IMF’s advice in its latest Article IV report. Moreover, real rates are now officially in positive territory, at both headline and core inflation levels, and with the expected further moderation in inflation, we see the CBE clearly having good room to cut rates. We maintain our forecast of a 50bps cut in the 15 Feb. meeting and 300-400bps in total throughout 2018.
Fixed income market probably too excited

The Treasuries market is pricing in a more aggressive rate cut of c150bps, with yields on T-bills having now declined, on average, 500bps from their peaks in July, even before CBE’s first rate cut, leading us to believe there is some room for a bounce-back in yields in the short term. Yields on the long-end of the curve are particularly offering low value for investors, but this largely remains function of the lower supply of bonds hence is unlikely to change in the short-term. We expect, though, the downtrend to continue over the coming few months before it moderates as we approach 2H18, where planned energy price hikes are likely to eliminate the favourable base effect and lead inflation to stagnate at 13-14%. In such environment, we see room for yields to regain some lost ground, at least for a few months, until the market gains more clarity on the inflation outlook.
What does all this mean for the carry trade?

We still see Egypt’s carry trade remaining attractive, despite heading to an easing cycle. Yields remain attractive, on a risk-return adjusted basis, with the macro story continuing to offer upside; the reform story continues, and risks on the FX remain to the upside. Alternative stories in the frontier-emerging space remain limited, in our view. Moreover, with inflationary pressures associated with fiscal reforms limiting room for an aggressive easing cycle, we see future yields continuing to offer value for investors (especially at the short end of the curve). Finally, the more flexible USD-EGP offers investors some return on the currency, which was absent last year, as flows went predominantly through the repatriation mechanism. This is now reversing gradually, with CBE quickly reaping the benefits of its decision to increase the cost of the repatriation mechanism with anecdotal evidence pointing that anywhere between 15-25% of YTD inflows into the carry trade are flowing through the interbank market vs. 1-3% last year.

Mohamed Abu Basha