US rate cut brings cheer to Kenyan investors

Economists say lower interest rates in the United States could benefit emerging markets by lowering the cost of dollar funding and other borrowing costs.

Lower interest rates on U.S. bonds can also often make assets from other countries more attractive, leading to an influx of dollars to buy shares on the Nairobi Stock Exchange and government securities.

Before Wednesday’s rate cut, U.S. interest rates were at their highest levels since 2001, as part of the Federal Reserve’s attempt to bring down inflation from its biggest rise in a generation.

But with consumer price inflation now running at 2.5%, close to the Fed’s 2% target, the central bank has signaled more cuts ahead.

Global stocks rose yesterday as investors sought to buy shares ahead of an expected rally amid the dollar’s weakness against major currencies and the decline in the attractiveness of investing in U.S. securities.

“Major emerging markets in Asia saw gains after the Fed announcement, and we expect emerging markets where Kenya is located to follow suit before the end of the year,” said Wesley Manambo, senior analyst at Standard Investment Bank in Nairobi.

“Foreign investors will be more inclined towards inflows as the opportunity cost of investing here is lower compared to developed markets.”

The September rate cut, which is expected to be followed by another half-percentage-point cut before the end of the year, is expected to realign global capital flows in favour of markets such as Kenya.

The Nairobi Stock Exchange, which has been stuck in a prolonged downtrend due to foreign investor selling, is expected to benefit from expected capital inflows from the United States as interest rates in the world’s largest economy fall in the coming months.

Over the years, foreign investors in the NSE have had a significant influence on the price movement of blue chip stocks such as Safaricom, EABL, Equity Group and KCB due to their deep pockets that allow them to dominate trading on the exchange.

The four largest companies account for 60% of the market capitalization of the National Stock Exchange of India, or investor wealth, a situation that has seen their moves impact the overall performance of the market.

“We expect to see some gains in valuations before the end of the year, as foreign capital flows into the market,” Manambo said.

Between 2020 and 2023, the NSE saw cumulative net outflows of Sh84.5 billion, initially due to investors fleeing to safety during the Covid-19 period as global economies slowed, and later due to rising interest rates in developed markets.

The tide has started to turn this year as foreign investors have started to take early bets on the domestic market in anticipation of a U.S. rate cut.

In the eight months to August 2024, foreigners made a cumulative net sales of Sh1.4 billion from the local market, narrowing from the net outflows of Sh17.8 billion in the corresponding period in 2023.

In yesterday’s trading, investors’ wealth on the NSE fell slightly by Sh3.2 billion to Sh1.676 trillion, even as the NSE 20 index rose 0.9 percent to 1,771 points.

Higher interest rates in the US had a negative impact on domestic interest rates after the Central Bank of Kenya was forced to raise its benchmark interest rate to keep Kenyan financial assets competitive for foreign investment and protect the shilling from further depreciation.

Banks have passed on the higher cost of deposits — caused by competition from attractive government paper — to borrowers. This has pushed the average lending rate by commercial banks to a nine-year high of 16.9% (before fees and risk premiums) by the end of July 2024.

Accordingly, a US rate cut would support the CBK’s recent stance of gradually easing the key interest rate, which began with a 0.25 percentage point cut to 12.75% at the MPC meeting in August 2024.

“We therefore expect the policy rate to be cut in subsequent MPC meetings in line with the prevailing macroeconomic conditions including low inflation… and ultimately this will be supportive of lower domestic interest rates,” said Churchill Ogutu, economist at IC Group (Mauritius).

For commercial banks, while lower interest rates mean lower interest margins, lower borrowing costs should ignite private sector demand for credit and reduce the stock of non-performing loans. The non-performing loan ratio hit an 18-year high of 16.3% in June 2024.

Investors benefiting from higher deposit rates, which rose from 7.8% in June 2023 to 11.48% in June 2024, should expect lower returns.

The Central Bank of Kuwait’s decision to raise its key interest rate to 13% earlier this year (before cutting it to 12.75% in August) has pushed interest rates on government bonds to highs of 18%, weighing on the treasury with higher domestic debt servicing costs even as investors enjoy higher returns on their holdings.

The higher yields on bonds compared to other domestic assets have led to an increase in the number of Kenyans investing in government securities.

By the end of last week, individual investors held a total of Sh757 billion in government securities, a 33% increase from the Sh571 billion they lent to the government at the beginning of the year.

The US rate cut, when reflected domestically, will boost the CBK’s efforts to lower local bond prices, as increased money flows due to the increased attractiveness of local bonds will strengthen the CBK’s grip on yields.

This will also provide opportunities for the government to tap cheap external commercial loans, particularly dollar financing.

“Kia typically taps the external commercial debt market in the second half of the financial year, so the US interest rate easing supports the issuance of Eurobonds or syndicated loans in that period to meet the Sh168 billion target from commercial lenders in FY24/25,” Mr Ogutu said.

The shilling has so far gained 21% against the dollar this year, meaning support from inflows from lower US interest rates is likely to be limited.

There was a positive reaction to the US interest rate decision as the shilling was trading at an average of Sh129.00 to the dollar in the interbank market on Thursday afternoon, after opening the day at an average of Sh129.20.

Similar to the NSE, the currency will benefit from increased foreign investor inflows into domestic equity and debt markets.

Major currencies such as the British pound, the Australian dollar, the Indonesian rupiah and the Chinese renminbi rose in the wake of the interest rate cut by the Federal Reserve.

A stronger shilling often reduces the country’s import bill, helping the central bank’s efforts to control inflation.

On the other hand, it reduces the profits transferred to exporters, which negatively affects the profits of tea, flower and vegetable traders.