US interest rates cuts won’t solve Kenyan asset problems, analysts say
A key reason why falling US rates won’t boost Kenyan assets as much as might be expected is that the historical driver of this positive trend doesn’t look set to change much.
The US is poised to cut interest rates for the first time since 2020 on Wednesday, with traders betting on the Federal Reserve acting aggressively to reduce borrowing costs in a trend that has historically helped assets in Kenya and other emerging markets.
This time will be different, financial experts say. While a fall in US rates could encourage inflows to Kenya, the trend is expected to be much milder than seen in past cycles.
The Central Bank of Kenya (CBK) beat the Fed to the punch—lowering its Central Bank Rate (CBR) by a quarter point in August—and is likely to continue cutting rates, meaning tailwinds for Kenyan stocks, bonds, and the shilling should be limited.
It is a near certainty that the Fed will cut rates on Wednesday, a landmark moment for global markets after the central bank’s most dramatic rate-hiking campaign in a generation to combat inflation from the Covid-19-era.
Historically, falling US interest rates—the global benchmark for borrowing costs—have been a tailwind for assets in emerging markets like Kenya, as investors tend to seek higher returns in riskier markets when risk-free returns in the US drop.
However, “the Fed’s upcoming monetary easing cycle will probably provide less of a tailwind to emerging markets than is widely thought,” Shilan Shah, an economist at research firm Capital Economics, wrote in a note.
A key reason why falling US rates won’t boost Kenyan assets as much as might be expected is that the historical driver of this positive trend—the differential between rates in the US and Kenya—doesn’t look set to change much.
Investors are only likely to significantly shift positions when there are material changes in the difference between borrowing costs in the US and countries like Kenya, and there are few signs that Nairobi’s rate-setters will themselves stop cutting rates.
“We expect the CBK to lower the CBR [again] in its October meeting,” analysts led by Renaldo D’Souza at Kenyan investment bank Sterling Capital wrote in a note.
“An accelerated rate reduction is likely in coming months in a bid to reduce government borrowing costs” in Kenya, Mr. D’Souza added.
If the CBK keeps pace with the Fed in lowering rates, then the expected positive impact on Kenyan assets will be limited. What remains a key question for traders is how big a rate cut is coming from the Fed, and how many more cuts in the coming months will be signalled by Fed Chairman Jerome Powell.
While it is likely that the Fed and CBK will act similarly in lowering rates in the coming months, it should be noted that growing expectations that the Fed will be faster than once thought in cutting borrowing costs have already impacted Kenyan bonds.
Since the beginning of the week, there has been an average drop of 70 basis points for Kenya’s infrastructure bonds—the most popular with offshore investors—according to Kenneth Minjire, a senior associate for debt and equity at broker AIB-AXYS Africa.
This has come as traders raised the odds of a bigger rate cut in the US, with there now being a 65 percent chance that the central bank will deliver a larger, half-point cut, based on interest-rate futures tracked by the CME FedWatch Tool.
More rate reductions than once expected from the Fed could grow the rate differential between the US and emerging markets, encouraging inflows to Kenya. However, even if the Fed acts more aggressively and the rate differential grows, other lingering factors could keep foreign investors away from Kenya.
“The equity market may not see an immediate reaction as risk appetite by offshore investors is still somewhat subdued and the dollar is still preferred as a safe haven due to heightened geopolitical risk,” says Mr Minjire.
