World Wheat Outlook Not as Heavy as Chicago Price Plunge Suggests

Commodity

Summary:

Exactly two years ago, Chicago wheat futures stamped all-time highs after top exporter Russia invaded fellow supplier Ukraine...

Exactly two years ago, Chicago wheat futures stamped all-time highs after top exporter Russia invaded fellow supplier Ukraine, immediately throwing almost 30% of global wheat exports into question.

But on Wednesday, CBOT wheat slipped to its lowest level since August 2020, joining the ranks with corn and soybeans, which last week also notched their lowest prices since late 2020.

In theory, global supply outlooks for wheat are not necessarily bearish, especially compared with those for corn and soybeans, though this wheat storyline clearly remains repetitive and non-threatening in traders' eyes.

U.S. Department of Agriculture estimates suggest 2023-24 global wheat ending stocks will decline for a fourth consecutive season to eight-year lows. Eleven-year lows are on the docket when excluding serial grain stockpiler China from the mix.

Isolating major wheat exporters, stocks-to-use, a measure of supply versus demand, is seen at a three-year low of 14.8% in 2023-24, down from 15.9% in the prior season. The recent 10-year average is about 16.9%.

For corn and soybeans, global stocks-to-use is pegged at 23% and 21%, respectively, marking four- and five-year highs.

The latest prognosis for wheat exporters is not much different from what USDA had projected for 2021-22 back in March 2022, roughly two weeks after the Russian invasion. Predicted stocks-to-use of 14% at that time was down from 15% estimated for 2020-21 and scheduled to reach 14-year lows.

Instead, wheat exporter stocks-to-use in 2021-22 rose on the year to 15.4%, as skyrocketing prices likely choked off some demand in the second half of that year. Stocks-to-use rose again in the following year based on an unexpectedly solid Ukrainian export effort and a huge surge in Russian supplies.

This expanding trend is already happening for 2023-24, as the 14.8% stocks-to-use among major exporters is up from 13.5% predicted last September, for example.

Export Pressure

Global wheat prices have been under pressure for months due to abundant supplies in top exporter Russia. Russian wheat shipments last month reached record volumes for February, and export prices have tumbled about 16% since Feb. 1.

Refinitiv data shows benchmark Russian wheat export prices this week slipped below $200 per metric ton ($5.44 per bushel) for the first time since August 2020, marking the lowest early-March price since 2017.

Ukraine's program is also going well, and as of Wednesday, season-to-date wheat exports are up 6% from a year ago. USDA is looking for a 12% annual decline in Ukraine's 2023-24 wheat shipments, so this could be up for revision on Friday in the agency's monthly supply and demand report.

CBOT wheat's settle on Wednesday of $5.31 per bushel is the most-active contract's lowest for the date since 2020, when wheat closed around $5.16. Speculators were relatively bullish wheat in early 2020, opposite to today's bearish views.

But funds' current net short in wheat is nowhere near as extreme as the ones in corn and beans, which is sensible based on the broad global supply picture for each crop.

CBOT wheat has shed 15% so far in 2024, a very similar decline as the same period last year, though prices are about 24% lower than a year ago and nearly 60% off the early March 2022 spike. World Wheat Outlook Not as Heavy as Chicago Price Plunge Suggests_2

World Wheat Outlook Not as Heavy as Chicago Price Plunge Suggests_2

Source: Reuters

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Owen Li

Commodity

Economic

China's imports of crude oil rose in the first two months of the year compared with the same period in 2023, but they were also weaker than the preceding months, continuing a trend of softening purchases by the world's biggest buyer.

Official customs data released on Thursday showed crude imports of 88.31 million metric tons in the January-February period, up 5.1% from the same period in 2023.

However, on a barrels per day (bpd) basis, the increase was only 3.3%, given the extra day this year in February for the quadrennial leap year.

Imports were 10.74 million bpd in the first two months, which were also down from the 11.39 million bpd in December, slightly better than November's 10.34 million bpd, and below the 11.53 million bpd in October.

China's crude imports in 2023 peaked in August at 12.43 million bpd, which was the second-highest on record, and although there has been some volatility in the monthly data since then, the overall trend is toward lower arrivals.

China combines import data for the first two months of the year to smooth out the impact of the week-long Lunar New Year holidays, which fall at varying times within the January-February period.

The question for the oil market is whether the increase in China's crude imports in the first two months on a year-on-year basis is more important than the declining trend.

It's worth noting that the imports for the first two months of the year were most likely arranged in a window from late October through to mid-December, a time when global crude oil prices were in a weakening trend.

Benchmark Brent futures hit their 2023 high of $97.69 a barrel on Sept. 28, before declining to a trough of $72.29 on Dec. 13.

This means crude that offloaded in the first two months of the year was mainly bought when prices were relatively low.

Since the December low, Brent has been rallying, reaching $84.05 a barrel on Wednesday, close to the 2024 high so far of $84.80 from Jan. 29.

The March 3 decision by the OPEC+ group of producers to extend their output cuts to the end of June has bolstered crude prices, but at the same time has raised questions over the strength of global oil demand given that the group is lowering production by a total of 5.86 million bpd, or nearly 6% of world demand.

The higher crude price of recent weeks also may act as a drag on China's imports from the second quarter onwards.

It's likely that the vast majority of cargoes arriving in March were secured weeks ago, but April and May shipments will have been subject to the higher prices since late January.

Flexible Buying

Chinese refiners have shown a willingness in the past to curb imports when they deem prices have risen too quickly or are too high, and they dip into inventories until they deem prices are more reasonable.

Another factor is China's exports of refined products, which fell in the first two months of 2024 compared with the same period last year.

Fuel exports were 8.82 million tons in the first two months, equivalent to about 1.18 million bpd, using the BP conversion rate of 8 barrels of products per metric ton.

This was down 31.4% from the 1.72 million bpd of products shipped in the January-February period last year.

Refiners were limited in the volumes they could because of a lack of quotas, and it is likely that export volumes will rise in coming months as quotas are released and refiners take advantage of still positive profit margins in Asia for diesel and gasoline.

The overall outlook for China's crude imports remains linked to the drivers of domestic fuel consumption and product exports.

However, the price of crude has also been a key determinant in recent months, with imports tending to rise when prices moderate, but ease off when costs increase.

No doubt exporters such as OPEC+ are hoping that China's economy recovers growth momentum, leading to stronger fuel demand, which may force the refiners to keep importing higher volumes of crude even if prices remain north of $80 a barrel.

Source: Reuters

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Remarks of Officials

According to the Fed's latest Beige Book, economic activity increased slightly since early January, with eight Districts reporting slight to modest growth in activity, three others reporting no change, and one District noting a slight softening.

Consumer spending, particularly on retail goods, inched down in recent weeks. Price growth pressures are still widespread in all jurisdictions, and inflation has eased to a certain extent in only a few jurisdictions. Several reports cited heightened price sensitivity by consumers, making it harder for companies to pass on higher costs. Households continue to reduce their consumption of non-essential items. While air travel was robust overall, demand for leisure and hospitality softened due to elevated prices, as well as to seasonality. Manufacturing activity was largely unchanged, and supply bottlenecks normalized further. Mortgage rates have moderated to some extent, but limited inventories hindered actual home sales. The outlook for future economic growth remained generally positive, with contacts noting expectations for stronger demand over the next 6 to 12 months.

Overall, labor market tightness eased further, with nearly all Districts highlighting some improvement in labor availability. For example, businesses generally found it easier to fill open positions and to find qualified applicants. Wages grew further across Districts, although several reports indicated a slower pace of increase.

Beige Book

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Cohen

Bond

Central Bank

Economic

An uneasy calm that has pervaded the U.S. bond market could break in coming days, as looming data on employment and consumer prices shed more light on how long the Federal Reserve might need to keep rates elevated in its battle to decisively defeat inflation.

While investors still expect rate cuts this year, unexpected economic strength has forced many to recalibrate how deeply the Fed will be able to lower borrowing costs without reigniting inflation, aligning the market’s views on easing more closely with those of the central bank. Yields on the benchmark U.S. 10-year Treasury, which move inversely to bond prices, have traded in a narrower range over the last few weeks.

Fed Chairman Jerome Powell echoed that sentiment on Wednesday, when he told lawmakers that continued progress on lowering inflation "is not assured" though the central bank still expects to cut rates in 2024.

Things could grow more precarious for bond investors if Friday’s employment data and next week’s consumer prices report show continued strength in the economy and more stickiness in inflation, further pushing back expectations for Fed cuts. That, in theory, could drive yields higher, further hurting investors who had jumped into Treasuries over the last few months betting on imminent easing.

"The worst case scenario for the fixed income market is if we get a ‘no-landing’ scenario, where the economic picture is still solid and inflation picks up,” said Lawrence Gillum, chief fixed income strategist for LPL Financial. “If we get that reacceleration in inflation or the economy, the 10-year could retest 5%”, he said.

In his remarks, Powell noted that inflation had "eased substantially" since hitting 40-year highs in 2022. He said there were risks of both cutting rates too soon and allowing inflation to reaccelerate, and of keeping monetary policy too tight for too long and damaging an ongoing economic expansion.

The 10-year yield was recently at 4.11%, little changed after Powell’s comments. Yields have bounced between about 4.05% and 4.35% since early February, following a swift decline from a 16-year high of just above 5% hit in October 2023.

That range of just over 30 basis points compares to a 38 basis point range from the start of the year through the first two trading days of February, and an almost 57 point swing in December.

'Worst Case' Inflation Fears Threaten Bond Market Calm as Powell Addresses Lawmakers_1

Futures tied to the fed funds rate on Wednesday showed traders pricing in about 90 basis points in rate cuts this year, much less than the 150 basis points they had priced in early January. The Fed penciled in 75 basis points of cuts in its projections late last year.

"If we get additional prints above 2% that will force the market to rethink the rate picture for the balance of the year,” causing more short-term volatility and a steepening of the yield curve, said Charlie Ripley, senior investment strategist at Allianz Investment Management.

Like many investors, however, Ripley believes the peak for rates likely came last year.

“Yields might move up marginally from a rangebound perspective, but this is an attractive entry point,” he said.

Net shorts in two-year Treasury futures last week fell to their lowest level since May, data from the Commodity Futures Trading Commission showed, suggesting lowered expectations for yields to spike further.

Others, however, are less certain that the economy will cool or the Fed will be in any hurry to ease monetary policy.

Easing financial conditions – including record high investment grade bond issuance, rising IPO activity, and new all-time highs for the US stock market – will likely continue to push inflation higher over the course of 2024 and undercut the case for rate cuts, warned Torsten Slok, chief economist at Apollo Global Management, in a March 1 note.

“The reality is that the US economy is simply not slowing down,” he said.

Economists polled by Reuters expect the U.S. to have added 200,000 jobs in February, after a blockbuster 353,000 jobs added in the previous month. The U.S. consumer price report, slated for March 12, is expected to show prices growing by 0.4% in February. Consumer prices grew at a faster than expected rate of 0.3% in the previous month.

“The market is going to be most sensitive to rates and rates are going to be sensitive to inflation, so we’re watching inflation more closely than anything right now as the predominant risk for markets,” said Michael Reynolds, vice president of investment strategy at Glenmede. “The next CPI report is going to be very closely watched.”

Source: Reuters

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Remarks of Officials

On March 6, local time, Federal Reserve Chairman Jerome H. Powell, presented the Federal Reserve's semiannual Monetary Policy Report, the testimony is as follows:

While inflation remains above the Federal Open Market Committee's (FOMC) objective of 2 percent, it has eased substantially. As labor market tightness has eased and progress on inflation has continued, the risks to achieving our employment and inflation goals have been moving into better balance.

The labor market remains relatively tight, but supply and demand conditions have continued to come into better balance. the unemployment rate has remained near historical lows, at 3.7%. Job vacancies have declined, and nominal wage growth has been easing.

The current restrictive stance of monetary policy is putting downward pressure on economic activity as well as inflation but is likely at its peak for the current rate hike cycle. However, the economic outlook is uncertain, and ongoing progress toward our 2 percent inflation objective is not assured. It may be appropriate to start cutting rates later this year.

Reducing policy restraint too soon or too much could result in a reversal of progress we have seen in inflation. At the same time, reducing policy restraint too late or too little could unduly weaken economic activity and employment. In considering any adjustments to the target range for the policy rate, we will carefully assess the incoming data, the evolving outlook, and the balance of risks. The Committee does not expect that it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2%.

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Daily News

[Quick Facts]

1. Japan's nominal wages rise more than expected, reinforcing the case for ending negative interest rates.

2. ADP employment rebounds, but wage growth hits a 2-year low.

3. Powell says the economy is not in recession but inflation progress cannot be assured.

4. JOLTS job openings unexpectedly increase.

5. Fed's Kashkari expects two rate cuts at most this year.

6. Fed's Beige Book shows moderate economic expansion.

[News Details]

Japan's nominal wages rise more than expected, reinforcing the case for ending negative interest rates

Data from Japan's Ministry of Health, Labor and Welfare showed that nominal cash earnings for workers rose by 2% year-on-year in January, higher than the revised 0.8% increase in December last year and exceeding expectations of 1.2%. Real wages fell by 0.6%, which was less than expected and the lowest decline in a year.

The annual pay talks between Japanese companies and labor unions are reaching a climax and the first results are expected to be announced next week. The Bank of Japan (BOJ) is monitoring wage trends closely for signs that a virtuous cycle linking higher pay with demand-led price gains is emerging. That's a precondition for the bank to end its negative interest rate policy, a move most economists expect to see this month or next. The data show accelerating wage growth, strengthening the case for the BOJ to end its negative interest rate policy in the near term.

ADP employment rebounds, but wage growth hits a 2-year low

ADP data released on Wednesday showed that U.S. ADP employment increased by 140,000 in February, falling short of expectations of 150,000 but exceeding the revised previous 111,000. Along with the job growth, annual pay increased 5.1% for those staying in their jobs, which was the smallest rise since August 2021. Year-over-year wage growth accelerated for the first time since November 2022 at 7.6%.

Fewer people are quitting their jobs, suggesting they may be less confident about finding a new or better-paying job. Despite the slowdown in hiring and pay growth, progress on inflation has brightened the economic outlook. Inflation-adjusted wages have improved over the past six months, and the U.S. economy appears to be heading for a soft landing.

Overall, U.S. firms started the year by adding fewer jobs than expected, consistent with a gradual cooling of the labor market. The hiring slowdown seen in 2023 extended into this January while wage pressures continued to ease.

The sharp decline in private sector job gains in January may be a sign that the growth in the U.S. labor market is slowing. Hiring slowed from its usual pace in nearly all sectors during the month. Market expectations for a rate cut have risen after the data was released.

Powell says the economy is not in recession but inflation progress cannot be assured

There's no evidence or no reason to think that the U.S. economy is in, or in some kind of, short-term risk of falling into a recession, Fed Chair Jerome Powell said in a testimony statement on Wednesday. There is a small risk of the economy falling into recession. As inflation progress cannot be assured, members can't be committed to the timing or pace of any rate cuts. Policymakers generally see price pressures easing, but there is also concern that the process of slowing inflation may stall.

There is a risk that the Fed will damage the economy by waiting too long before cutting rates, but the Fed is also reluctant to ease credit conditions too soon and cause inflation to re-accelerate.

Rate cuts depend heavily on the path of the economic development. Our goal is to achieve full employment and price stability. We will closely watch the upcoming data releases that will affect the outlook. Before lowering the policy rate, it would be nice to see more data confirming that inflation is moving back toward 2 percent in a sustainable manner to gain more confidence.

In this hearing, Republican lawmakers, who make up the majority of the House of Representatives, were particularly concerned about bank regulation. Lawmakers from both parties largely refrained from pressuring Powell on interest rates. They didn't require him to cut rates as soon as possible nor to delay easing to ensure that inflation is under control.

JOLTS job openings unexpectedly increase

U.S. JOLTS job openings were 8.863 million in January, compared with the expected 8.85 million. The December figure was revised downward to 8.889 million from 9.026 million. The job openings rate, which is computed by dividing the number of job openings by the sum of employment and job openings, was 5.3% in January, unchanged from December.

There are 1.4 jobs available for every unemployed person. The rate, which was 1.2 before the pandemic, has been trending downward overall over the past year or so.

About 3.39 million people quit their jobs, the fewest in three years. The rate of quits was 2.1%. The more the quits, the tighter the labor market and the more confident workers are to leave their current jobs for better opportunities, and vice versa. The figure has fallen significantly in recent months, signaling that Americans are less confident that they can find other jobs in the current market or get new jobs that pay better.

Overall, the number of job openings in the U.S. remained high in January and demand for workers remained strong.

Fed's Kashkari expects two rate cuts at most this year

Minneapolis Fed President Kashkari said on Wednesday that he had penciled in two interest-rate cuts in 2024 last December. He hardly thinks that this year's rate cuts will exceed his expectations based on data that have been released. There may be one less cut, but it has not yet been decided.

If the economy remains resilient and inflation is more entrenched than expected, the first thing we'll do is leave rates unchanged for a longer period.

Fed's Beige Book shows moderate economic expansion

The Federal Reserve's Beige Book, published on Wednesday, shows that economic activity has increased slightly since the beginning of January, with eight districts seeing slight or moderate growth, another three districts seeing no change in economic activity, and one seeing a slight slowdown.

Consumer spending, particularly on retail goods, has declined modestly in recent weeks. Pressure on price growth remains widespread across all districts, with only a few districts showing some moderation in inflation. At the same time, firms are finding it more difficult to pass on higher costs to customers as consumers are becoming more sensitive to price changes.

Labor market tensions eased further, with improvements in labor supply and employee retention in almost all districts. Several reports indicated a slowdown in wage growth. More constrained labor costs may further reduce inflationary pressures that spiked unexpectedly earlier this year.

[Focus of the Day]

UTC+8 21:15 ECB Interest Rate Decision (March)

UTC+8 21:45 ECB President Lagarde Holds Monetary Policy Press Conference

UTC+8 00:30 Next Day: Cleveland Fed President Mester Speaks on the Economic Outlook

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ING

Economic

Central Bank

Forex

Central bank accelerates reform process

Egypt's central bank yesterday took long-awaited measures to allow more FX flexibility, a key step in its ongoing reform process that should be seen as a positive for investors. After an unscheduled 600bp rate hike on 6 March, the authorities announced they would allow "the exchange rate to be determined by market forces", looking to unify the official and parallel exchange rates and clear the FX backlog that has been holding back the economy. This step has been anticipated by the market for a while, but a clear trigger was the recent significant announcement of foreign investment from the UAE, including $24bn in new funds from wealth fund ADQ purchasing development rights for the region of Ras El-Hekma.

The EGP has fallen by almost 40% since the announcement versus the USD to near 50, having been held steady at around 31 since early 2023. This brings the exchange rate towards the reported parallel rate and in line with the devaluation priced in by 3-month NDF contracts, although 12-month forwards still point to investor expectations of a further weakening beyond 55 over the next year. Egypt: Reforms Picking Up Steam_1

EGP NDF shows investors welcomed the measures

The drop in EGP to 50 against the dollar has hit global headlines, but is a mere realignment with the parallel and non-deliverable-forward market. The 12-month NDF is trading around 55, which is around 5% above its 52.2 Tuesday close and some 0% above spot, which implies relatively limited risk priced in of more sharp devaluations.

Despite the hit on the pound today, USD/EGP 12M NDF has reversed less than half of the decline (i.e. EGP appreciation) since late February, which was triggered by news of an IMF deal, and the pound is some 17% stronger than the 66.7, 31 January high in the forward tenor.

We deem markets' reaction as quite encouraging, and the EGP forward curve now signals some cautious optimism on the medium-term success of new reforms.

Investor optimism, but more work to be done

The clear positive for investors is that there have been multiple clear and coordinated actions from Egypt to show commitment to policy orthodoxy and reform. The combination of large investment commitments from the UAE, significant interest rate hike and FX devaluation, along with an upgraded IMF agreement, could drive a virtuous cycle of improved investor sentiment and potentially more comfortable access to international bond markets. Following the central bank's policy announcement, the IMF agreed to increase Egypt's outstanding funding package from $3bn to $8bn and passed its outstanding reviews.

Yesterday's measures are far from signalling that it is job done for Egypt, however. The step FX devaluation will ideally be followed by a more free-floating exchange rate, in order to avoid Egypt getting stuck in the same cycle it has been in recent years. 2016 saw a significant devaluation and pledges to float the exchange rate, while there were also several step devaluations in 2022 before the EGP was returned to being tightly managed. This will leave some lingering scepticism for investors about a definitive shift in government policy. Egypt: Reforms Picking Up Steam_2

Disinflation process at risk

A clear issue for Egypt has been the pass-through from exchange rate weakness to spiralling inflation – this has meant that despite the significant cumulative nominal FX depreciation over the past decade, competitiveness gains as shown by the real effective exchange rate (REER) have been gradually eroded by elevated inflation. Egypt: Reforms Picking Up Steam_3

In this context, the 6 March 600bp rate hike by the central bank is a key step, and likely more aggressive than market expectations. Inflation spiked in 2017 to over 30% YoY on the back of a sharp devaluation of the EGP, while 2022 and 2023 saw an even more difficult picture, given the addition of wider global inflation pressures to the multiple step devaluations of the exchange rate. The latest FX devaluation is likely to put further inflationary pressures on Egypt, so the central bank will now be hoping for some stability in the EGP to give the chance for the cumulative effect of rate hikes to have an impact on activity and prices. Egypt: Reforms Picking Up Steam_4

IMF to act as reform anchor

While the latest policy steps have been taken as a positive by investors, the IMF remains a key player for Egypt. The nation's outstanding package was marred by delays due to lack of reform progress. Egypt is already the IMF's second largest debtor, with some $15bn in repayments due over the next five years, while a $3bn agreement was reached in October 2022. Yesterday's agreed increase in the size of funding to $8bn looks important given Egypt's overall financing needs and the scale of economic challenges (including around $5.5bn annually in Eurobond principal and interest payments over the next four years).

However, perhaps of more importance is the perception of the IMF as an anchor to keep economic reforms on track, which in turn helps to improve investor confidence, and can act as a catalyst for further foreign investment. Egypt: Reforms Picking Up Steam_5

Devaluation and official flows should help correct external imbalances

Egypt's currency pressures and economic struggles were triggered by the multiple global shocks in recent years (Covid, war in Ukraine, and global interest rate hikes), but exposed some imbalances and vulnerabilities in the economy. Egypt was previously reliant on foreign investment flows into both international bonds and local currency T-bills to fund a persistent current account deficit.

This meant that when the global risk-off environment drove investor outflows from local currency debt, and international bond markets were largely shut for issuance from riskier sovereigns, the central bank was forced to sell down a significant amount of its FX reserves to defend the currency (from a peak of $44.7bn in February 2020 to $31.3bn in August 2022). This raised investor concerns about the ability to continue servicing external debt and brought even sharper focus onto official flows such as IMF loans and deposits from the Gulf Cooperation Council (GCC). Egypt: Reforms Picking Up Steam_6

Egypt's current account deficit has already started to correct narrower, from 4.4% of GDP in late 2021 to nearer 1% as of third quarter 2023 as global tourism and trade and have recovered, while the latest FX devaluation is hoped to further support the adjustment in the trade balance through improved competitiveness and import compression. In this scenario, the large inflows from the IMF and UAE investment could be used to rebuild Egypt's central bank reserves and improve the nation's external balance sheet.

Geopolitical factors remain a risk for Egypt, given the reliance on transit receipts via the Red Sea and Suez Canal, along with tourism, that could be depressed by the war in Gaza. However, in this respect, Egypt's strategic importance has been reaffirmed for both regional partners such as the GCC sovereigns (especially the UAE and Saudi Arabia) and also Western nations, a clear factor in the recent commitments of support.

Fiscal consolidation a medium-term challenge

While reform progress has been clear in asset privatisation, foreign investments and exchange rate policy, Egypt's fiscal situation remains difficult and could be a drag on further improvements on the nation's credit profile. The government has shown restraint in maintaining a primary surplus in recent years, but large interest payments that eat up some 40-50% of government revenues are a clear structural restraint that will be difficult to solve. The overall budget deficit is running larger on a cumulative basis this fiscal year than in previous years, touching 5.9% of GDP in January (fiscal year runs July-June). Egypt: Reforms Picking Up Steam_7

As a positive for Egypt's debt sustainability, despite a large government debt load (over 90% of GDP) and interest costs, much of this debt is held domestically, in local currency. This reduces FX risks, along with having a much more captive domestic investor base. The growing share of official sector debt will generally carry exchange rate risk, but much lower rollover risk than commercial debt. The Eurobond stock (which tends to be among the riskiest form of debt for EM sovereigns) is not insignificant, but even there a significant share is held domestically, rather than by foreign investors, which tends to mean holders are stickier, and repayment of this debt means less of a drain on FX in the system. Investors will still be looking for clear signs of fiscal consolidation and an eventual downward trend in debt-to-GDP, but near-term risks are in general lower than many high-yield sovereigns. Egypt: Reforms Picking Up Steam_8

Sovereign credit spreads have rallied sharply

In terms of investor perception of sovereign risk, Egypt is among the top performers in the EM HC space this year, with total returns YTD over 20%, following a couple of volatile years. The recovery, in particular since late October, has seen Egypt's hard currency bonds back out of distressed territory (credit spreads over 1000bp) after serious default concerns in 2023. Current yields in the high single digits still look prohibitive to sustained Eurobond market access for the country's financing needs, so Egypt is not out of the woods yet, but the most acute phase of the crisis seems to be over.

With spread levels now compressing towards the average for single-B sovereigns and tight to some African peers, the near-term rally is likely running out of steam, in particular with most clear catalysts out of the way. For a further compression of credit spreads for Egypt, investors will likely need to see more concrete structural reforms, clearer signs of genuine FX flexibility and potential plans for future Eurobond market access. Egypt: Reforms Picking Up Steam_9

Our view on USD/EGP

The situation in Egyptian markets remains volatile, although the evidence of a cautious optimism by the investors community after recent domestic developments leaves some space for USD/EGP to stabilise. The new level is significantly easier to defend by local authorities, and the short-term focus should be on stabilising around the 50 level as opposed to rushing into a further floating of the currency, especially given the ongoing risks to inflation and geopolitical events. Official reserves currently amount to USD33bn, which amounts to around four months of current account payments. We think authorities will use any appreciating pressure on the pound short-term to reinforce the reserves position. Egypt: Reforms Picking Up Steam_10

The transition to a more flexible market-determined exchange rate is probably on the cards later this year, but should be gradual and only occur once Egyptian authorities are comfortable this will not lead to excessive market selling pressure.

Global conditions may start to matter more once the dust has settled. Our view that the Fed will cut rates from June and for a total of 125bp this year-end implies a less stressful environment for emerging market FX and debt.

We are still far from a situation where the EGP's stellar carry is able to lure back FX flows on a sustainable basis, but we now expect Egypt to succesfully keep the currency close to the 50 mark in the coming months before a transition to free floating range potentially poses fresh downside risks on the pound.

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