10-Aug-2017
Egypt Economics - Room for further USD-EGP appreciation is likely as reserves rise to record
Rising NIR reflects the CBE’s comfort with carry trade size
We believe the USD5bn jump in Net International Reserves (NIR) in July, sending it to a record high, was largely driven by the inclusion for the first time of foreign holdings of Treasury-bills in headline reserves (see Fig. 3). The policy shift reflects, in our view, the CBE’s comfort in that these holdings have reached a critical mass whereby it can be used to boost confidence in the new FX regime. Holdings reached USD14bn by early August, more than doubling following the past two rate hikes and beating the historical peak of USD11.4bn in September 2010 by a decent margin. The policy shift has clearly added more excitement to carry traders who remain aggressive buyers of local debt with some seeing it as a pretext for further EGP appreciation.
USD-EGP to maintain gradual appreciation
Higher reserves are providing further legs to USD-EGP’s gradual appreciation that has been slowly materializing, in line with our expectations; USD-EGP appreciated 1.7% since June. The appreciation has been very gradual and relatively small, but marks a clear break from the past six-month trend. We continue to see room for further appreciation with the biggest catalyst being an alteration to the existing repatriation mechanism in order to allow flows from the carry trade, the source of FX flows into the system, to go through the interbank market. Our expectation of appreciation though is a relatively limited one in the next six months, with EGP17 the likely ceiling as we expect only a gradual further recovery in tourism and FDI flows.
Yields likely to correct as cuts set for later in the year
The sharp increase in foreign flows into the debt market has caused yields to plunge, effectively erasing the entire rally since the CBE first hiked policy rates back in late May. Foreign flows were so strong that anecdotal evidence suggests that the secondary market is back to being active to provide further supply to the primary market. While the rapid flows explain the fall in yields, we believe it is largely overdone and expect a reversal of this trend over the next few weeks. While we have argued that the tightening cycle has come to an end, we still don’t see major prospects for a rate cut before 4Q17. As such, we expect the CBE to leave policy rates on hold in its next meeting on 17 August.
We believe the USD5bn jump in Net International Reserves (NIR) in July, sending it to a record high, was largely driven by the inclusion for the first time of foreign holdings of Treasury-bills in headline reserves (see Fig. 3). The policy shift reflects, in our view, the CBE’s comfort in that these holdings have reached a critical mass whereby it can be used to boost confidence in the new FX regime. Holdings reached USD14bn by early August, more than doubling following the past two rate hikes and beating the historical peak of USD11.4bn in September 2010 by a decent margin. The policy shift has clearly added more excitement to carry traders who remain aggressive buyers of local debt with some seeing it as a pretext for further EGP appreciation.
USD-EGP to maintain gradual appreciation
Higher reserves are providing further legs to USD-EGP’s gradual appreciation that has been slowly materializing, in line with our expectations; USD-EGP appreciated 1.7% since June. The appreciation has been very gradual and relatively small, but marks a clear break from the past six-month trend. We continue to see room for further appreciation with the biggest catalyst being an alteration to the existing repatriation mechanism in order to allow flows from the carry trade, the source of FX flows into the system, to go through the interbank market. Our expectation of appreciation though is a relatively limited one in the next six months, with EGP17 the likely ceiling as we expect only a gradual further recovery in tourism and FDI flows.
Yields likely to correct as cuts set for later in the year
The sharp increase in foreign flows into the debt market has caused yields to plunge, effectively erasing the entire rally since the CBE first hiked policy rates back in late May. Foreign flows were so strong that anecdotal evidence suggests that the secondary market is back to being active to provide further supply to the primary market. While the rapid flows explain the fall in yields, we believe it is largely overdone and expect a reversal of this trend over the next few weeks. While we have argued that the tightening cycle has come to an end, we still don’t see major prospects for a rate cut before 4Q17. As such, we expect the CBE to leave policy rates on hold in its next meeting on 17 August.
Mohamed Abu Basha