21-Mar-2019
Egypt Economics: The USD-EGP - How long can the appreciation last?
The EGP is riding the tide of EM flows
The EGP has seen some notable appreciation YTD, with the pace accelerating rapidly over the past couple of weeks as Egypt continues to enjoy rapid inflows into its local debt market. Emerging markets, at large, enjoyed some decent inflows YTD, with Egypt having, in our view, its fair share of these flows, given its strong macro fundamentals (improving external balances, favourable foreign reserve position and high yields). This is also the same trend we are currently seeing in Nigeria, the other lucrative carry trade within the emerging/frontier space, where the country saw some significant inflows into its local debt markets, post presidential elections (see Fig. 4 & 5). We think the latest wave of inflows is now seeing late comers to the trade who want to snatch some exposure to Egypt’s carry trade story, banking on potential normalisation of inflation, bringing about some decent expansion in real yields. This investment position, together with the already high nominal yields investors have locked, justifies their investment positions at current FX levels; meaning that any potential FX loss is: i) likely to be contained (1-2%); and ii) compensated by the high carry. On the other hand, early comers are not necessarily very tempted to sell now, despite their significant gains, probably because we are still very early in the year (1Q has not even closed yet); hence, they are mostly tempted to stay, given the lack of other lucrative investment opportunities.
Domestic demand is still in a typical wait-and-see mode
A key supporting factor for the EGP uninterrupted rally is, as always, the so-far muted domestic demand. Locals were initially surprised by the appreciation, given that all projections at the end of 2018 were pointing to a weaker USD-EGP. Thereafter, locals have largely taken the usual position of fishing for the bottom of the appreciation, given that the currency’s rally has hardly taken a breather during the past few weeks. Current prices are clearly tempting for local businesses to lock, but it seems many are waiting for even better prices, given the continued appreciation of the currency. In a way, this brings back to mind the sharp appreciation of the EGP in early 2017, though we do not think an exact replica will be the most likely scenario (Fig. 8).
EGP17.10+/- could be a potential short-term stabilisation point
Calling the bottom of the appreciation is tricky, given how risk-averse foreign investors are recently turning towards the EGP. We think, however, that an appreciation higher than 4-5% will start to take away from the attractiveness of the EGP’s carry; thus, this could be a point where foreign buying starts to taper off. We, therefore, see that EGP17.10+/- could potentially be a point of stabilisation in the short term. As for the remainder of the year, we expect to see increased volatility, especially in 2H19, when investors are likely to be more tempted to realise their profits, given that, by then, real yields should normalise, and the risk for some weakness in the EGP should increase. We, therefore, reiterate our view that the USD-EGP will likely trade within a band of EGP17.40/50-18.00 throughout the year; we have tweaked our FY18/19 forecast to reflect the recent appreciation. We see investors remaining interested in the carry trade in the medium term, given the favourable outlook for both the external and fiscal sectors, with reforms to be included in key global indices for the domestic-currency debt market being a key catalyst for a duration trade.
Mohamed Abu Basha
The EGP has seen some notable appreciation YTD, with the pace accelerating rapidly over the past couple of weeks as Egypt continues to enjoy rapid inflows into its local debt market. Emerging markets, at large, enjoyed some decent inflows YTD, with Egypt having, in our view, its fair share of these flows, given its strong macro fundamentals (improving external balances, favourable foreign reserve position and high yields). This is also the same trend we are currently seeing in Nigeria, the other lucrative carry trade within the emerging/frontier space, where the country saw some significant inflows into its local debt markets, post presidential elections (see Fig. 4 & 5). We think the latest wave of inflows is now seeing late comers to the trade who want to snatch some exposure to Egypt’s carry trade story, banking on potential normalisation of inflation, bringing about some decent expansion in real yields. This investment position, together with the already high nominal yields investors have locked, justifies their investment positions at current FX levels; meaning that any potential FX loss is: i) likely to be contained (1-2%); and ii) compensated by the high carry. On the other hand, early comers are not necessarily very tempted to sell now, despite their significant gains, probably because we are still very early in the year (1Q has not even closed yet); hence, they are mostly tempted to stay, given the lack of other lucrative investment opportunities.
Domestic demand is still in a typical wait-and-see mode
A key supporting factor for the EGP uninterrupted rally is, as always, the so-far muted domestic demand. Locals were initially surprised by the appreciation, given that all projections at the end of 2018 were pointing to a weaker USD-EGP. Thereafter, locals have largely taken the usual position of fishing for the bottom of the appreciation, given that the currency’s rally has hardly taken a breather during the past few weeks. Current prices are clearly tempting for local businesses to lock, but it seems many are waiting for even better prices, given the continued appreciation of the currency. In a way, this brings back to mind the sharp appreciation of the EGP in early 2017, though we do not think an exact replica will be the most likely scenario (Fig. 8).
EGP17.10+/- could be a potential short-term stabilisation point
Calling the bottom of the appreciation is tricky, given how risk-averse foreign investors are recently turning towards the EGP. We think, however, that an appreciation higher than 4-5% will start to take away from the attractiveness of the EGP’s carry; thus, this could be a point where foreign buying starts to taper off. We, therefore, see that EGP17.10+/- could potentially be a point of stabilisation in the short term. As for the remainder of the year, we expect to see increased volatility, especially in 2H19, when investors are likely to be more tempted to realise their profits, given that, by then, real yields should normalise, and the risk for some weakness in the EGP should increase. We, therefore, reiterate our view that the USD-EGP will likely trade within a band of EGP17.40/50-18.00 throughout the year; we have tweaked our FY18/19 forecast to reflect the recent appreciation. We see investors remaining interested in the carry trade in the medium term, given the favourable outlook for both the external and fiscal sectors, with reforms to be included in key global indices for the domestic-currency debt market being a key catalyst for a duration trade.
Mohamed Abu Basha