Weekly Fixed Income Comment – 25 September 2017
As previewed in last week’s Note, the US Federal Reserve was one of the most important features of last week as they both confirmed the gradual wind down of their balance sheet (i.e. unwinding QE or quantitative easing) and released the latest economic projections and dot plots (i.e. their current views about how many rate hikes will be required over the next few years). So far, with the ECB and BoJ (Bank of Japan) still increasing their balance sheets (i.e. more QE), the markets are of the view that lower involvement of the Fed in the US Treasury market will not have a major impact. According to this view, the rise in US Treasury yields last week was largely a function of stable dot plots, unlike last time when a number of Fed members reduced their expectations about rate hikes. Overall, the Fed members expect 1 more hike this year (presumably in December), 3 hikes next year and 2 in 2019. This number of rate hikes remains far higher than priced in by the markets, which expect just over 2 hikes over this whole period. Notwithstanding this difference, the Fed generally is still moving to the view that the long-run Fed funds rate is somewhere around (just) 2.50 to 3.00%.
Risk assets, whether equity markets or non-government bond markets, had another fairly quiet week, continuing the trend of a less active and less volatile September than many had expected. Credit spreads for MENA markets were mixed. Economic data around the world continues to be robust, even if the hurricanes are negatively impacting the US during this quarter. Whilst questions continue to be asked about risks in China, the authorities seem to be in charge still and are not slamming on the brakes even if S&P did downgrade China from AA- to A+ related to credit growth and the resulting increase in debt. Oil prices remain firm and hence friendly for GCC/ MENA credits as the cross-currents of the US hurricanes, an apparent slowdown in new shale rigs in the US, OPEC production cuts, Turkish/ Kurdish tensions, inventory drawdowns of both crude and refined product, and demand growth support prices. The North Korean crisis remains less friendly.
As we write the last Note of the third quarter, the last month has been typical of the year-to-date with risk generally being rewarded. Over both periods equities have been the best performers, notably emerging market equities in US dollar terms given the weakness of the greenback this year, with local currency, emerging market bonds not far behind (indeed they have performed better than most, developed country equity markets). Elsewhere in fixed income it has also been a beta trade with high yield bonds also doing well, US Treasury returns are positive but at the back of the pack. It is quite possible that this pattern remains in place for the rest of the year.
Bond Funds & Mandates
In The Region
MENA credit was generally stable last week. With lot of regional investors being on holiday at the end of the week for Islamic New Year, activity and liquidity was limited. Such activity as was tended to be in bonds and sukuk in the major indices with two-way flow in Omani credits, for example. The newly issued Bahrain bonds and sukuk saw some profit taking and traded below re-offer.
Preparations for the introduction of VAT in parts of the GCC continue with the Saudi Arabian government approving further regulations regarding the tax that cover all VAT-related areas. In another reform initiative, the Kingdom is considering further subsidy cuts that would raise domestic prices for gasoline and jet fuel by around 80% from November, as well as car fuel prices. There are also reports that they will introduce a new bankruptcy law next year to make the country more investment friendly.
In the UAE, consumer price inflation declined further in July to 1.2% year-on-year from 2% in June and 3% at the end of the previous quarter, reflecting a fall in both tradable and non-tradable inflation. Housing (34% of the CPI basket) inflation continued to move down, to under 1%. Average housing price inflation has been increasing at a slower pace with a rise of 1.7% for the first half of this year against 4.2% during the same period in 2016 and 8.8% in 2015.
The geopolitical situation continues to negatively affect the Qatari economy. The latest data showed that the hospitality sector is on a downward trend. The country recorded a drop of 18% in its visitor numbers from GCC countries in the first seven months of 2017. Hotels in Qatar have also been operating on around 50% occupancy during the past three months.
The litigation regarding the validity of USD 700 million of sukuk issued by Dana is resuming this week in London after several delays last week. In June, Dana said that it would not repay holders of its Islamic bond because it had become invalid under UAE law. The sukuk holders are hoping a ruling that effectively shuts down Dana's legal campaign in both jurisdictions.
ISDB issued USD 1.25 billion, 5-year sukuk priced at mid-swap + 37 bps. Supply continues to be lower than had been expected but Saudi Arabia has announced a roadshow for next week which may mark the start of more notable activity.
Out of Region
The JP Morgan EMBI Global Diversified (US dollar denominated, sovereign, emerging market bonds) lost 40 bps last week. The main detractor was the return from underlying US Treasuries, negative 31 bps. Asia was the best performing region with a loss of 11 bps and Africa was the worst with a loss of 65 bps. Belize, Suriname and Venezuela performed well with an average gain of 267 bps, while Ukraine, Zambia and Egypt performed poorly with an average loss of 111 bps. High grade bonds performed better than high yield.
For the corporate sector, the CEMBI Broad Diversified (US dollar denominated, corporate, emerging market bonds) lost 3 bps also due to US Treasuries, spread related returns were positive for this index. Latin America was the best performing region with a gain of 12 bps while Africa was the worst performer with a loss of 28 bps. Consumer was the best performing sector with a gain of 14 bps while Industrial was the worst one with an 11 bps loss.
In the local currency markets, the JP Morgan GBI-EM Global Diversified index was up 14 bps in US dollar hedged terms last week. Currency returns were negative with the unhedged returns recording a lower gain of 3 bps. Europe was the worst performing region with a loss of 23 bps, while Latin America was the best one with a gain of 41 bps in hedged terms. Hungary and Peru were the best performing countries with 91 bps gains each in US dollar hedged terms. The market is expecting further easing in Hungary due to the downward shift in inflation, whereas the newly appointed cabinet in Peru following the no-confidence vote should boost public spending to reach desired growth targets. Argentina and Brazil also performed well with gains of 78 bps and 69 bps respectively in US dollar hedged terms. The 2018 budget in Argentina could trigger GDP warrant payments if growth is above 3% as assumed. Furthermore, the budget includes a 12% increase in investment, 4% primary deficit and average inflation at 15.7%. The Brazilian economy was officially out of recession with the Q2 numbers and the reform agenda remains on course. On the laggard side, Turkey was the worst performer last week with a loss of 86 bps in US dollar hedged terms, negatively affected by the geopolitical issues in its neighboring countries particularly the Kurdish referendum at the moment. Moreover, the latest data show a primary budget surplus of TRY 4.6 billion which is a 45% drop from the same period last year. Czech Republic and Poland also performed poorly with 37 and 35 bps losses respectively in US dollar hedged terms. The central bank in Czech Republic remains worried about increasing inflation. Inflation is also the drag on the Polish bond market, Polish unemployment reached 7% in August which is its lowest level since 1991.
In FX markets, the Philippine peso, Russian ruble and Polish zloty performed well last week. The laggards were Turkish lira, South African rand and Indonesian rupiah.
Our internal systems show that the MENA Bond Fund (MBF) was down by 21 bps in the week to 22nd September. The Bloomberg USD UAE Index was down 12 bps and the JP Morgan MECI (Middle East Composite) was down 21 bps, so MBF was in line with the market. According to the 20th September NAV, MBF was up 3.84% year-to-date. The yield of MBF is 4.22%.
Sukuk Income Fund (SIF) was down 12 bps, in the week to 22nd September according to our internal systems. The JP Morgan MECI Sukuk was down 21 bps and the Dow Jones Global Sukuk Index was down 15 bps, so SIF was fractionally better than or in line with the market. The 20th September NAV shows that SIF was up 1.96% year-to-date. The profit rate for SIF is 4.45%.
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