Carry Trade Roars Back in Egypt as Yield Hunters Pounce on Bonds

(Bloomberg) -- Investors enticed by high yields and a cheaper currency are piling into Egypt’s local bonds at a record pace after a policy turn earlier this month unlocked tens of billions of dollars in financial assistance.

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Bids submitted in auctions for Treasury bills surged to historically high levels after Egypt’s devaluation on March 6 as the risk of further currency depreciation dissipated and the premium to hold them surged to a record over other emerging-market notes. Demand for 364-day bills jumped to more than 400 billion Egyptian pounds ($8.5 billion) in a single auction this month, the highest ever, with investor appetite strong across the maturity curve.

Egypt increasingly stands out for carry traders, who borrow where rates are low to invest where they are high. The local currency has been gaining against the dollar since it was allowed to weaken by more than 38% three weeks ago, a decision accompanied by Egypt’s biggest-ever interest rate hike.

“Investors had waited for an inflection point in the local market story to get involved in size in carry trade positions,” said Samir Gadio, head of Africa strategy at Standard Chartered Bank.

Egypt has won pledges this year of over $50 billion in investment and loans in a global bailout that included a $35 billion deal with United Arab Emirates, the largest inward investment in the North African nation’s history. The UAE’s pledge paved the way for the long-awaited currency flotation and an $8 billion expanded International Monetary Fund program.

Egypt’s Treasury bills are trading at their widest discount ever relative to other emerging-market debt, according to data compiled by Bloomberg. The gap between the official exchange rate and the pound’s non-deliverable forward contracts narrowed sharply after the devaluation, signaling an expectation of a more stable currency in the market.

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“There’s been huge demand at the auctions because foreign portfolio investors are eager to lock in current levels of the currency as arguably the pound has overshot with such a large amount of foreign reserve coming,” said Gordon Bowers, a London-based analyst at Columbia Threadneedle Investments. Demand for the bills “has been overwhelmingly strong as they offer plenty of buffer to absorb any future currency depreciation.”

“While T-bill auction demand is still robust, it could moderate further from recent record highs as yields ease,” Gadio said. “There was probably a lot of T-bill demand front-loading immediately after the devaluation.”

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Investors previously shunned Egypt’s local debt as the central bank resisted a devaluation of the heavily managed pound. It became overvalued in the eyes of foreign traders, contributing to shortages of hard currency that caused inflation to soar.

The size of the bailout and the speed of the turnaround in investor sentiment warrant caution, though, according to Thierry Larose, a portfolio manager at Vontobel Asset Management AG.

“Pouring money into a relatively small economy and sudden investment flows bring risks,” Larose said. “I expect at some point in the future that the Egyptian government may make some mistake, then the exit door will be extremely narrow. For us, Egypt is more a tactical play rather than a strategic view on the long-term development of the country.”

Meanwhile, the extra yield investors demand to own Egypt’s dollar bonds rather than US Treasuries traded below 600 basis points on Wednesday, according to indicative data from JPMorgan Chase & Co, dropping from the 1,000 basis-point level widely considered by investors to signal that an asset is in distress.

“The combination of the policy shift and significant external financing has transformed Egypt’s macro outlook and will continue to support the investment thesis in Egyptian risk assets,” Kevin Daly and Clemens Grafe, analysts at Goldman Sachs Group Inc., said in a note.

“We expect a continued appreciation of the pound on the back of strong FX inflows, a sharp decline in inflation and rates over the next 12 months, and a strengthening of external buffers on the back of a vastly improved external financing outlook,” they said.

--With assistance from Mirette Magdy and Selcuk Gokoluk.

(Updates with Goldman Sachs comments in final two paragraphs.)

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