World’s best carry trade intact as Egypt pivots to rate cuts

Following last week’s 100 basis-point reduction in lending and deposit rates, investment bank CI Capital predicts Egypt will extend the easing with a further two percentage points of cuts through the rest of the year. Renaissance Capital sees rates one percentage point lower by end-2019 and a “few hundred” basis points of reductions in 2020.

The outlook is unlikely to dent the pound’s appeal as a carry trade, in which investors borrow in currencies where rates are low and invest in the local assets of countries where they are high. With foreign inflows into Egypt’s government securities ending months of declines in January, the pound has appreciated more than 2 per cent against the dollar in 2019.

“Lower policy rates are not a threat to foreign inflows or inflation,” said Hany Farahat, senior economist at CI Capital. “Market expectations of an easing cycle will encourage fixed-income investors to lock in high yields before further drops.”

While fuel subsidy cuts expected around midyear will fan inflation and price growth picked up to an annual 12.7 per cent in January, the Monetary Policy Committee attributed the recent acceleration to “unfavourable base effects.”

The MPC led by Governor Tarek Amer said the rate cut is “consistent with tight real monetary conditions.” It remains committed to bringing inflation to its target of 9 per cent, plus or minus 3 percentage points, by the fourth quarter of 2020, according to a statement.

The central bank acted days after the International Monetary Fund’s disbursement of a loan tranche of about $2 billion (Dh7.34 billion). Meanwhile, foreign holdings of local debt climbed $900 million last month alone, a reversal from 2018 when foreigners sold around $10 billion in Egyptian Treasury bills and bonds as a rout swept across emerging markets.

Egypt’s focus now is on cutting the budget deficit by reducing the cost of servicing debt and boosting the real economy, which were among the factors for the decision on rates last week, Amer was cited as saying on Sunday.

In its first bond auction following the central bank’s meeting, the Treasury showed it wouldn’t rush to meet investors’ demand for a premium, accepting bids for just over half the 17 billion-pound ($967 million) amount targeted. Average yields dropped by 75 basis points and 86 basis points on three- and nine-month T-bills, respectively.

“The rejected bids were presumably asking for higher yields,” analysts at Naeem Holding, an investment bank based in Cairo, wrote in an emailed note.

Helped by the inflows, the pound is trading near 17.54 versus the dollar, the strongest in almost two years, according to prices compiled by Bloomberg. Renaissance Capital reckons it’s about 2 per cent cheaper than the currency’s “long-term fair value” of 17.1, whereas it would be in Egypt’s interest to keep it 10 per cent weaker.

“The authorities want the pound to remain competitive,” said Charles Robertson, RenCap’s London-based chief economist