The chairman of the US Federal Reserve has indicated that it intends to cut interest rates by as much as 75 basis points in 2024, an announcement that is fuelling optimism in emerging and frontier markets in Africa.
Since March 2022, the Federal Open Market Committee has voted to hike rates on 11 occasions in an attempt to bring down inflation in the US, which peaked at 9.1% in June 2022. The benchmark Federal Funds Rate currently stands at a two-decade high of between 5.25% and 5.5%, having been practically at zero during the coronavirus pandemic.
Higher interest rates in the States helped feed into a stronger US dollar, with foreign exchange traders incentivised to obtain greater exposure to the greenback by the promise of higher yields. In turn, many African currencies posted steep declines against the dollar, making imports and commodities priced in dollars more expensive in local terms and therefore contributing to higher levels of inflation.
Elevated interest rates and a stronger dollar have also made it more expensive for African countries to service dollar-denominated debt, something that has helped push many countries on the continent into debt distress. According to the World Bank, nine African countries are now in debt distress and a further 15 are at “high risk” of being unable to fulfil their repayment requirements. Zambia and Ghana have already defaulted on their debts, with Ethiopia poised to follow suit.
Will the dollar weaken?
The news that the Federal Reserve is likely to begin easing monetary policy next year is raising hopes that these burdens could start to be lifted. Charlie Robertson, head of Macro Strategy at FIM Partners in London, tells African Business that “when the dollar does well, emerging markets do badly, and when emerging markets do badly, Africa does particularly badly… hopefully a lower Federal Funds Rate equals a weaker dollar, equals emerging market currencies doing a bit better, and then onto Africa.”
However, Robertson notes that higher rates in the US are only one reason that explain the sharp depreciation of many African currencies in recent years.
“For the last 10 years or so, African currencies have held up stronger than they should have done against the dollar,” Robertson says. “Nigeria, Kenya, and Egypt are just a few examples.”
“Firstly, China’s Belt and Road Initiative meant that nearly a trillion dollars was being lent to low-income countries globally. Secondly, global rates were so low that Kenya could go out and borrow $5-6bn a year. Thirdly, the HIPC Initiative on debt forgiveness meant that all these governments came into the 2010s with relatively low levels of debt, so they could afford to borrow more,” he explains.
This meant that African countries were consistently able to secure strong inflows of US dollars and prop up the value of local currencies.
“But all that has stopped in the last two years. The Chinese have taken back more money than they have lent. Nobody wanted to lend when the Fed funds were giving you 5% returns. And debt has reached unsustainably high levels. All the reasons that kept currencies strong have stopped,” Robertson says.
These more fundamental trends mean that many African currencies are not necessarily on a sound long-term footing, even if a weaker dollar allows them to make gains in 2024.
Higher yields could attract investors
Regardless, there are several potential positives associated with lower rates in the US and a weaker dollar. For instance, with returns on dollar assets coming down, portfolio investors could be encouraged to look more closely at opportunities in African markets in the hope of securing higher yields.
Robertson says that “there’s no sign of that on the equity side right now – Nigeria, for example, is getting excluded from the MSCI Frontier Index as of February.” However, he is encouraged that there could be opportunities in fixed income. In particular, frontier bonds that are denominated in local currencies rather than the US dollar could become more attractive.
“We’ve seen frontier dollar bond funds do very well – partly because they are making good money on the dollar side,” he notes. But the prospect of a weaker dollar next year could mean “that the local story becomes more interesting in 2024 – Kenya, for example, could get interesting.”
Some African currencies could also be set to make gains against the dollar in 2024 as rates come down and traders start to consider which currencies are undervalued, creating further opportunities.
“I was struck by Zambia’s currency, which is about 10% cheap. You still have strong global demand for copper and copper prices have held up well despite the global slowdown. Kenya is going to get interesting because the interest rates there are more attractive in a currency that was 20% overvalued but is now 5% cheap,” Roberton says.
“Nigeria’s interest rates are currently in deeply negative territory – they are well below one year market rates – but if that gets resolved, Nigeria’s currency looks interesting. Egypt could get interesting after a devaluation,” he adds.
“There’s going to be a lot of opportunity in African currencies and interest rate markets in 2024.”
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