Macro Analysis /

Egypt: The end of the inverted yield curve?

  • The yield curve finally normalised after being inverted for 3 years since EGP floatation

  • Treasury yields show correlation with CBE benchmark rates; short-term tenors fell as a response to recent cuts

  • Egypt shows a high risk- high reward treasury investment profile, yet offers one of the highest real yields among EMs

Al Ahly Pharos Securities Brokerage
14 April 2020

The yield curve finally normalised in March 2020, to a slope of 1.2%, breaking the 3-year long inverted curve pattern which started in December 2016, right after the start of the floating exchange rate regime in November 2016. Historically, the yield curve has always had a positive slope. In December 2016, the short-term yield jumped up significantly from 11.5% in January 2016 to 19.0% in December 2016, while the long-term end inched higher from 15.8% to 16.0%, over the same period. 

Short-term treasury bills have also been the main drivers of the shift back to a normal sloping yield curve, even though all yields have been gradually and slowly falling since 2018. The yield curve shift to an upward slope in March 2020 is due to the Central Bank of Egypt's (CBE) recent interest rate cut of 300bps, driving benchmark rates to their normal levels of 9.75% and consequently, bringing down yields. The short-term end was more responsive to the cut; the 3M yield fell from 19.7% in December 2018 to 12.85% in March 2020, and similarly, the 10-year yield fell from 18.1% to 14.0% over the same period. 

The inverted yield curve did not predict a recession, although it is widely famous for this conclusion. The inversion of the curve in this case was a reflection of the market’s expectations that those high yields would fall soon since they were judged too high to be sustained; rather than a reflection of lack of investor confidence in the government’s ability to pay back its debt in the long term. 

The yield curve should remain upward sloping. Unless the coronavirus pandemic causes inflation to spike up dramatically, requiring the CBE to raise rates again.

Treasury yield follows the movements of CBE benchmark rates

The treasury yields are generally moving in tandem with the CBE’s benchmark rates. The 1 year T-bill yield has been moving along with the Mid-Corridor rate since 2005. However, in March 2020, after the CBE cut interest rates by 300bps to a Mid Corridor level of 9.75%, the 1-year yield fell by less than 100 bps, to 14.1% from 14.75% by the end of 2019. in 2020, the correlation was more visible with the short tenor instruments, as 3M and 6M yields have been more volatile and responsive to the interest rate cuts in March than the 1-year yield. 

We can see that the yield also shows some correlation with inflation; whereby after the floatation and the subsequent jump in inflation, yields have risen to attract FPI and defend the EGP when real income was eroded by a the currency weakness and annual inflation that is north of 30%. Currently, with inflation expectations more tamed, and if the EGP avoids volatility expected from USD outflows, yields should remain low. 

The yields are not the only indication of demand on treasury instruments. Over 2016-2019, the coverage ratio (submitted/ accepted) rose to 2.5-3.2, going back to its levels in 2007-2010, suggesting that the demand on treasury instruments was growing and peaked in 2020. On the supply side, the supply ratio (accepted/ required) inched up in 2017 then started to fall slowly until 2020. The bottom-left graph shows that while the CBE’s supply growth was rather stable, demand jumped coincidentally with the jump in weighted averaged yields over the same period.

Egypt offers a high risk-high reward profile on treasury yet gives the highest real yield

After the start of the coronavirus pandemic in early March 2020, all EM economies saw their yields increase and their CDS rates almost double. In a comparative context, Egypt offers a high reward – high risk profile for investment. However, of all the countries, Egypt offers the highest real yield among EMs and of course higher than developed economies who are currently operating at negative real yields.