US Federal Reserve Hikes Rates As Shilling Tries To Wade Through The Storm

The Kenya Shilling remained relatively stable and resilient last week, losing by 0.2 percent against the dollar to close the week at 102.2 shillings from 102.0 shillings the previous week.

The shilling remained stable despite:

1. The 25-bps hike in the Federal Funds Rate, which saw the dollar reach a 14-year high globally.
2. Rising dollar demand from local importers as the year comes to a close.

On a YTD basis, the shilling is flat having gained 0.1 percent against the dollar. In recent weeks, the forex reserves have reduced to USD 7.2 billion from USD 7.8 billion in October, which has led to the decline in the months of import cover below the 1-year average of 4.9 months, and is currently at 4.7 months, down from 4.8 months recorded previous week. Just 2-months ago, on 6th October 2016, there was 5.2 months of import cover.

The US Federal Reserve

The US Federal Reserve’s Open Market Committee (FOMC) met during the week, on Wednesday 14th December, 2016 to agree on a path for the US monetary policy and decided to increase rates to between 0.50 – 0.75 percent from 0.25 – 0.50 percent previously.

The decision by the Fed to hike rates was based on:

• Economic Growth – US economic growth has improved, with the GDP having grown by 0.8, 1.4 and 3.2 respectively in Q1’2016, Q2’2016 and Q3’2016, the highest growth levels experienced in the last 2-years.
• Employment – The US employment rate has improved over the last 12 months, with unemployment currently at 4.6 percent as compared to 5.0 percent in a similar period last year, indicating a strengthening labor market.
• Inflation – Inflation has been increasing, having hit a 2-year high of 1.6 percent as at October 2016, and is now just 40 bps shy of the 2.0 percent target.

In addition to raising rates by 25 bps during this meeting, the Fed is expected to accelerate its rate-hiking pace now that the economy is expected to do even better come 2017.

This is likely to lead to global strengthening of the US dollar, hence resulting in:

1. Weakening of other currencies including the Kenya Shilling, which is likely to come under pressure especially in the short to medium term.
2. Higher debt obligations for countries with US dollar denominated debt as their debt service and debt repayments will cost more with the strengthening dollar.
3. A reduction in prices of commodities, especially gold. With the 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 1-year average of 4.9 months.

The inflation rate has been increasing gradually since June 2016, after hitting a low of 5.0 percent in May 2016, and is currently at 6.7 percent as at November.

Interesting to note is that the low-income segment of Nairobi has seen the largest impact throughout the last half of 2016 with fuel price rises adversely affecting kerosene users and basic food item price rises worsening the situation.

This is despite:

• An increase in diesel and kerosene prices as highlighted in the December 2016 Energy Regulatory Commission (ERC) report.
• An expected trickle-down effect on the cost of energy, transport and food.
• Increased consumer spending given that the festive season has just begun, the high base effect of last year should cure for cyclicality and therefore there are no major threats to high inflation in the country as yet. However, following the Organization of Petroleum Producing Countries’ (OPEC’s) decision to reduce crude oil production by 1.2 mn barrels/day starting January 2017, we are likely to see a rise in inflation as local fuel prices follow the upward trend of global crude oil prices.

Key to note is that crude oil prices have already begun to rise, having hit USD 57.0 per barrel up from USD 46.0 per barrel in November, and up from lows of USD 25.0 per barrel experienced earlier in the year. The increase in oil prices is likely to impact the currency negatively, as well as the current account position to worsen given the increased spending on oil importation in 2017.

Related: No Merry as Fuel Prices Set to Push Up Transportation Cost, Inflation