The USD lost ground last week and remains on the defensive at the start of this week. As investors eased bets that the Fed would hike rates aggressively, so the USD lost some of its attraction, leaving most currencies to regain some lost ground. For context, the USD is overvalued against most currencies, and by quite some margin. The USD is at least 25% overvalued on a trade-weighted basis when considering data spanning the past forty years. This suggests that we could see some of the strength in the USD moderate in the months ahead, which would provide some much-needed reprieve for emerging market currencies.
In the commodity market, Brent crude has topped $120 per barrel this morning, supported by news that China is easing its COVID lockdown restrictions, allowing manufacturers to resume operations from June. This is the first time since late March that Brent has topped this level, and it keeps the benchmark on track for a sixth-straight monthly gain, the longest bull run we have seen in decades. There is the risk that China could reimpose some curbs going forward, but it seems that the worst is over for now, which will support oil prices as we see economic activity normalising there.
Meanwhile, EU nations this weekend failed to agree on a revised sanctions package for Russia, which would have included bans on imports of Russian energy. However, talks on this matter will continue this week, with officials suggesting yesterday that a deal could be reached over the next few days. Speculation that a ban is near has seen the oil futures curve turn heavily backwardated, with the prompt-spread surging to over $3.60 per barrel from $1.30 per barrel at the start of the month.
Ethiopia: Data from the Finance Ministry revealed that since the war between federal troops and rebels in the northern Tigray region began, Ethiopia’s lenders have reduced lending to the country. In the first nine months of this fiscal year, Ethiopia received only $774.85mn in disbursements, most of which came from the World Bank’s International Development Association. That compares with $1.41bn in 2020/21 when the war began and $3.1bn in 2019/2020. Ethiopia declared a truce on March 25 after about a year and a half of violence. However, fresh dissent has emerged since the announcement of the cessation of hostilities, as groups that were previously allied to the central government oppose reconciliation efforts.
Nigeria: Nigeria’s ruling party, the All Progressives Congress, has moved its presidential primaries to 6-8 June after the electoral agency granted political parties a six-day deadline extension to conclude the selection of flag-bearer candidates. Meanwhile, a court has ruled that former President Goodluck Jonathan can contest in next year’s presidential election, clearing his eligibility and paving the way for him to return to national politics. President Buhari signed a constitutional amendment in 2018 seeking to bar vice-presidents from serving more than one full term in the event of succeeding a president through death, impairment, or ill-health, a hurdle that Jonathan had to clear. The court said that the new amendment was not binding on Jonathan.
Tanzania: The World Bank on Friday committed $550mn through the International Development Association to support Tanzania’s transport project. According to the lender, the financing will allow Tanzania to unlock roads and airport bottlenecks. Tanzania’s Transport Integration Project aims to improve safety, climate resilience, the capacity of road corridors regional airports and enhance the country’s role as a transit country, and more effectively leverage its national parks for tourism. The project includes upgrading, rehabilitation of about 500km of roads, three regional airports, and the development of institutional capacity.
Chad: To benefit from higher oil prices currently, the International Monetary Fund on Friday called on Glencore Plc and other creditors to swiftly complete an agreed restructuring of Chad’s $1bn in private debt. Chad last year agreed to rework its debt with its private and bilateral creditors under the G20 Common Framework but has yet to agree on the terms/conditions. Roughly one-third of Chad’s $2.8bn external public debt is owed to a consortium of private creditors, including Glencore. IMF Africa Director Abebe Aemro Selassie was quoted as saying, “Chad needs more of the revenues it has to support its economy, to support its people. The fact that Chad’s creditors haven’t yet completed debt restructuring that the country desperately needs is causing difficulties.” Under the terms of Chad’s loan from Glencore, debt-service repayments increase as crude prices rise and vice versa.
Malawi: As part of measures to address foreign exchange shortages that a surge in commodity prices has exacerbated, Malawi’s central bank devalued the Kwacha by 25% against the dollar. The central bank ordered authorized dealer banks on Thursday to adjust the exchange rate from the mid-rate and “align it to the market-clearing level” from May 27. Governor Banda added that the first devaluation in a decade will allow the exchange rate to adjust toward a “managed float” regime and “reflect market fundamentals. The devaluation comes a day after the government started talks with the International Monetary Fund for a new extended credit facility.
Forex: Nigerian Naira finds support from the rate hike, but the outlook remains bleak
The Nigerian Naira has found some support in recent sessions following the surprise rate hike delivered by the central bank last week. Recall the Central Bank of Nigeria delivered its first rate hike since July 2016, joining a host of central banks on the continent that have hiked their policy rates to curb inflationary pressures and support portfolio inflows. Pulling back the lens, it is worth noting that the Naira has been Africa's third-best performing African currency on a year-to-date basis against the USD, up by 2.14%. Aside from higher oil prices, the Naira has also been propped up by CBN support. For context, data from the central bank showed that the bank had injected a total of $3.36bn into the foreign exchange market between December and January as part of efforts to ensure the currency's stability. $1.71bn and $1.65bn were injected in December 2021 and January 2022, respectively.
While the Naira on the official and parallel market may find some support on the back of the rate hike in the short-term, pressure will remain unabated due to dollar shortages. Dollar shortages will continue and be exacerbated by the increased political spending as primary elections take place. Meanwhile, low production of oil and theft, which is negatively impacting government revenue and accretion to the country's external reserves, which are used to defend the Naira, are further headwinds.
Concerns that the Naira is overvalued, a lack of flexibility in the exchange framework, and liquidity constraints are some of the factors weighing on investment in Nigeria, and hence the rally in short-term yields is unlikely to meaningfully bolster portfolio inflows. Our in-house measures indicate that the Naira is overvalued by around 9% on a real effective exchange rate basis. It is worth highlighting that the non-deliverable forwards are currently pricing in depreciation to just below 485 over the next 12 months.
Fixed Income: Political uncertainty likely to result in wider risk premiums
While much of the focus at the moment for fixed income traders is centred on global monetary policy, politics are likely to add to the drivers of price movements in Angolan, Kenyan and Nigerian bonds, with the three countries set to head to the polls in the months ahead. Kenya’s presidential election will take place on August 9, while Angola’s general election is likely to take place between August and December. Nigeria’s presidential election will only take place in 2023. That said, Nigerian political parties need to elect their presidential candidates by 6-8 June.
History shows that there is a strong correlation between rising political uncertainty and increased price action in a respective bond market. The more uncertainty about an outcome of an election and the impact on fiscal and macroeconomic policy, the higher the risk premium demanded by investors. Traditionally, elections in Kenya have been characterised by violence. With President Uhuru Kenyatta in his final term, the election looks set to boil down to Deputy President William Ruto and Raila Odinga. Odinga and Ruto have both pledged support for the marginalised communities if they become president, using policies that will increase government spending to drive economic growth. Given the fiscal degradation that has taken place in recent years, this will concern investors and likely result in an increased fiscal premium.
In Angola, the People's Movement for the Liberation of Angola (MPLA), which has ruled for 46 years, confirmed that incumbent president Jao Lourenco would be the party's candidate in the presidential elections. That said, Lourenco and his MPLA party will confront a newly formed opposition coalition known as the United Patriotic Front (UPF), led by Adalberto Costa Junior of the National Union for Total Independence of Angola (UNITA). Recent polling data shows that the Presidential race will be hotly contested, with the ruling party's lead over the main opposition narrowing to 7 percentage points. As political dynamics heat up, we expect the risk premium baked into Angolan, Kenyan and Nigerian bonds to rise.
Macroeconomic: Kenyan expected to leave rates on hold, but there is still an outside chance of a rate hike
While central banks across the world have embarked on tightening cycles, with more than 60 central banks hiking interest rates this year, consensus expectations suggest that the Central Bank Kenya will leave its bench interest rate on hold at 7.00% today. Inflation in Kenya, which currently sits at 6.5% y/y, remains within the central bank’s 2.5%-7.5% inflation target band. Therefore, economists expect policymakers to keep monetary policy accommodative to support economic growth despite mounting inflation pressures.
There will also be political pressure to leave rates on hold ahead of the upcoming presidential election later this year as the ruling party looks to bolster its chances of another term in power. Recall that Kenya’s cabinet recently approved to continue paying fuel subsidies in a program aimed at softening the blow of increasing prices despite further straining public finances. The government has been subsidising fuel prices by tapping a Stabilization Fund that’s capitalised through a levy of KES 5.40 per litre of gasoline and diesel.
While the fuel subsidy has helped soften the blow of elevated international commodity prices on domestic consumer prices, inflation risks in Kenya are tilted to the upside as the currency continues to weaken. While the Kenyan Shilling has been depreciating over the past few months due to the stronger USD, increased USD demand from importers and deterioration in risk appetite, inflation risks in Kenya are modest compared to other African nations, given the limited risk of currency passthrough. The economy is weak, and the credit cycle soft, with money supply growth anchored well below its long term average at 4.75%, limiting the potential for a spike in inflation.
That said, we are of the view that a rate hike can’t be ruled out as rates across the globe continue to rise. While inflation risks remain relatively contained, the Central Bank of Kenya would want to maintain its monetary policy differential with the US to provide some support for the local currency, which has come under stern selling pressure in recent months. Therefore, we do see a considerable risk that the Central Bank of Kenya’s hikes rates today.