Markets & Finance

US interest rate rise likely to pile pressure on shilling

Money-Shilling

Analysts said the knock-on effect is also likely to affect sovereign debt issues such as the Kenyan Eurobond, if investors start demanding a premium to lend to emerging economies. PHOTO | FILE

The shilling is likely to come under pressure going into the New Year following a decision by the US Federal Reserve to raise its base lending rate, analysts said.

The move to raise the US rate to 0.75 per cent from 0.5 per cent—as widely expected in the market—is likely to strengthen the dollar globally, which coupled with a shift in capital back to the US would place emerging market currencies under depreciation pressure.

Analysts said the knock-on effect is also likely to affect sovereign debt issues such as the Kenyan Eurobond, if investors start demanding a premium to lend to emerging economies.

A weaker shilling would also result in higher cost of repayment for dollar-denominated loans.

“This (rate increase) is likely to lead to global strengthening of the dollar, hence resulting in weakening of other currencies including the shilling, which is likely to come under pressure especially in the short to medium term, and higher debt obligations for countries with dollar-denominated debt as their debt service and debt repayments will cost more with the strengthening dollar,” said Cytonn Investments in its latest weekly bulletin.

“With the Central Bank of Kenya (CBK) expected to step in to protect the shilling, we expect to see a reduction in our foreign exchange reserves with the months of import cover moving further below the one-year average of 4.9 months.”

Yields on the five-year and 10-year Eurobonds rose last week by 24 and 31 basis points to five per cent and eight per cent  respectively, which has been tied to the demand by investors of a premium on emerging market debt.

A weaker shilling carries the implication of raising the cost of living for Kenyans, given that the country is a net importer of goods.

It would, however, offer a benefit for exporters, whose goods sold to external markets would fetch more value once they convert their proceeds to shillings.

READ: KIRAGU - What US Fed interest rate hike means for Kenya

The US Fed is tipped to make three more rate increments next year, with the incoming administration having indicated that it intends to pursue a stimulus policy that includes tax cuts and increased domestic spending.

Unlike the currency, however, the transmission of the higher US rate to the domestic debt market is likely to be less pronounced, according to analysts.

The government is already ahead of schedule on domestic borrowing, meaning there is room for it to reject expensive money coming into the market.

“Rates in the short to medium term are unlikely to be unaffected by the Fed hike, with effects being felt in the next hike, which will most likely happen next year. The currency might come under pressure though,” said NIC Securities fixed-income trader Stanslaus Kimani.

The domestic debt market is also dominated by local investors, who have lower exposure to the dollar than their international counterparts.

Last week, Treasury took up only a third of the Sh35 billion offered by investors in this month’s two-year bond issue, leaving Sh25 billion on the table in what traders said was a refusal to take up debt at a rate higher than the average market yield.

Equities dominated by foreigners are expected to continue suffering as higher US rates lure investors.