FED rate cut: The resounding effects (Part 1)

“WHEN the Federal Reserve acts, the world listens,” perfectly captures the significance of the US Federal Reserve’s recent 50 basis point rate cut on 18th September 2024 – its first in four years-ushering in a pivotal global monetary shift.

Following years of aggressive rate hikes to combat inflation, this decision signals a strategic transition toward fostering economic growth.

As global borrowing costs fall and capital flows shift, the Bank of Tanzania (BoT) faces a critical juncture.

Opportunities for increased foreign investment arise, but challenges such as inflation management and currency volatility are equally pressing.

The BoT must deftly navigate the impacts of the Fed’s actions to maintain economic stability in Tanzania, a balance I intend to explore in detail.

Capital Inflows: With the Fed’s rate cut and the potential for further reductions, as indicated by Mr Powell, Chair of the Federal Reserve, Tanzania is well-positioned to attract increased capital inflows from global investors seeking higher returns in emerging markets, driven by easier borrowing conditions.

These inflows are expected through channels such as Foreign Direct Investment (FDI), Portfolio Investment, Remittances and even Foreign Aid and loans.

A notable example is the Mahenge Graphite Project, which secured 219 million US dollars in funding from POSCO, CRDB Bank, DBSA and IDC in September 2024.

These inflows could trigger currency fluctuations as the Tanzanian shilling adjusts to the Fed’s rate cut, as discussed further.

Currency Volatility: Currency volatility from a weaker US dollar could impact Tanzania in several ways.

An appreciating shilling would lower import costs, easing inflation, but hurt exports by making them less competitive, while reducing the burden of USD denominated debt.

Conversely, a depreciating shilling would raise import costs, driving inflation, but improve export competitiveness and boost revenues.

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However, it would increase the cost of servicing foreign debt.

The Bank of Tanzania must carefully manage monetary policies while also addressing the impact of increased money supply on liquidity, inflation and economic stability.

Money Supply: The expected influx of foreign capital in Q4 2024 is likely to expand Tanzania’s money supply, and if not carefully managed, could lead to inflation, driving up prices for housing and commodities.

Increased liquidity may also fuel credit growth, leading to a rise in consumer loans for housing, vehicles and further activity in the equity and bond markets.

Analysis of Equity Market: Liquidity on the equity market decreased progressively from 17th to 19th September 2024.

While the market started with strong liquidity on 17th September with turnover of 153.91m/-from 192,618 shares and 390 deals, liquidity on the following day stood at a turnover of 100.68m/- from 123,717 shares and 182 deals and on 19th turnover was at 116.28m/- from 94,517 shares and 148 deals.

From these three days, CRDB and NICO stocks remained highly liquid throughout this period, absorbing a large portion of trading activity.

Analysis of Bond Market: In the bond market, the CRDB 5-year bond’s yield dropped significantly from 14.9903 per cent on 17th September to 11.4922 per cent on 18th September, reflecting strong demand for short-term securities following the Fed’s rate cut, as investors sought higher returns in Tanzanian bonds over global options.

Yields for 20-year bonds, like Bond No. 528 and Bond No. 540, also fell slightly, showing cautious optimism amid increased liquidity.

In contrast, the 25-year Bond No. 568 saw its yield rise from 14.0219 per cent to 15.4993 per cent, indicating investor hesitancy towards long term commitments due to inflation concerns and expected future rate adjustments by the Bank of Tanzania.

Analysis of NCPI – August 2024: The National Consumer Price Index (NCPI) for August 2024 shows a 3.1 per cent inflation rate, up from 3.0 per cent in July, while core inflation fell slightly to 3.2 per cent.

Despite stable inflation, underlying pressures could worsen with increased money supply, especially due to the Fed rate cut – as per the Quantity Theory of Money, which may drive capital inflows into Tanzania.

Analysis of Central Bank / IBCM Rate: As of Q3 2024, Tanzania’s central bank rate stands at 6.0 per cent while the 7 day- IBCM rate for 19th September stood at 8.33 per cent, reflecting a relatively tight monetary stance aimed at controlling inflation and managing the balance of liquidity in the market.

With an expected influx of foreign capital and the global impact of the Fed rate cut, this 6.0 per cent rate may well play a key role in mitigating inflationary risks – temporarily.

A continued rise in capital inflows could lead to excess liquidity and if not managed through timely adjustments in the central bank rate (CBR) and IBCM rate, inflationary pressures may increase.

Consequently, the upcoming 233rd Monetary Policy Committee (MPC) meeting on October 2nd, will be crucial in addressing these risks and ensuring economic stability.

In Part 2 of this issue, coming on October 1st, we will delve into the potential outcomes of the MPC meeting and their implications, while also evaluating how Tanzania can best respond to these unprecedented rate cuts, the first in 1,464 days. Stay tuned for in-depth insights!