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Fiscal Policy Back On The Menu

Weekly Fixed Income Comment – 02 October 2017

Overall Markets

Fiscal policy came back on to the agenda last week as the beginnings of a tax package in the US was announced, electioneering in Japan ahead of the October 22nd general election paved the way for easier policy and speculation that Merkel’s poor showing in the German election, along with a Wolfgang Schauble’s departure from the Finance Ministry, will lead to easier fiscal policy in Germany. Monetary policy was given a boost by Yellen’s comments that downplayed low inflation a little and the latest speculation about Yellen’s replacement as Fed Chair, if she is replaced, being more hawkish. All in all, this has boosted the US dollar (with the Spanish mess undermining the euro) and pushed government yields higher, the 10-year US Treasury yield reaching a 2 month high at 2.35% and the market pricing a 70% chance of another rate hike in December.

The US tax package announcement was very light on detail and a lot of negotiation lies ahead, the scale of any changes in Japan and Germany are also uncertain. The debate within the Fed about the appropriate path of monetary policy remains vigorous. Notwithstanding the initial market moves noted above, there is enough uncertainty to keep the markets guessing and ranging for now. However, global growth data continues to be in good shape. Some of the Chinese data released in September was a little weaker but the latest PMI was firm and other data around Asia has been good. Hurricane impacts aside, US data continues to be good even if inflation remains low.

Global demand growth continues to be a positive factor for oil prices. After establishing 2 ½ year highs (for Brent amongst other grades) just below USD 60/bbl, oil prices have pulled back a little. However, the market is still in backwardation in keeping with growth, the OPEC/NOPEC production cuts sticking, US hurricanes and political tensions with respect to production in places such as Iran, Iraq (Kurdish areas) and Venezuela. Not all these forces will remain so positive over time but the range that has been in place since early 2016 seems set to remain intact.

Bond Funds & Mandates

In The Region
MENA credit was generally stable last week although the Saudi bond market underperformed slightly ahead of the new KSA issue with yields up by around 12 bps. In the event the new issues were well received with an oversubscription of  3.2 times for the USD 12.5 billion of 5, 10 and 30-year bonds.

Saudi Arabia’s economy contracted further in Q2 2017. Gross domestic product (GDP) shrank 2.3% from the previous quarter in Q2 after dropping 3.8% in Q1, and was down 1.03% year-on-year. The latest contraction is not surprising given the government spending cuts and subdued consumer demand. Nevertheless, the government remains committed in its efforts to diversify the economy although non-oil sector growth remains below 1%, and has slowed the pace of some reforms. Saudi stock indices fell on Sunday after news that FTSE had decided to delay including Riyadh in its secondary emerging market index (while Kuwaiti blue chips were strong after FTSE included Kuwait, with effect from September 2018). In its annual review, FTSE praised Riyadh’s market reforms but said it would need more time to evaluate their practical impact and will assess Saudi Arabia again next March.

In Qatar, latest economic data indicate poor, economic conditions with growth reaching its lowest level of 0.6% year-on-year for Q2, compared to 2.5% for Q1. On a quarter-on-quarter basis there was a slight improvement from the negative 1.5% in Q1 to plus 0.5% in Q2. Hence, the Qatari economy was slowing before the geopolitical issues. Economists expect Qatar’s economy to expand 2.5% this year which would be the slowest pace since 1995.

In the UAE, the government continues to show commitment to the OPEC agreement on oil production cut, ADNOC will reduce its daily production further in November. The economy remains resilient due to a gradual pick up in non-oil sector, growth is still expected to be over 3% this year. A number of new taxes came into effect on October 1st, a new source of income for the UAE government, with targeted items being soft drinks and cigarettes. A 50% tax on carbonated, sugary drinks and a tax on energy drinks and tobacco products of 100%. The World Health Organization is supporting countries such as the UAE for imposing heavy excise taxes to curtail tobacco demand and boost healthy behaviour.

Following Bahrain and Saudi Arabia, Jordan is planning to issue a USD 1 billion, 30-year maturity and Abu Dhabi is issuing 5, 10 and 30-year bonds. October is shaping up to be a lot busier than September in the primary market.

Out of Region
The JP Morgan EMBI Global Diversified (US dollar denominated, sovereign, emerging market bonds) lost 9 bps last week. The main detractor was the return from underlying US Treasuries, negative 38 bps. Latin America was the best performing region with a gain of 13 bps and Asia was the worst with a loss of 30 bps. El Salvador, Zambia and Iraq performed well with an average gain of 160 bps, while Nigeria (following headlines of USD 5.5 billion issuance in Q4), Tunisia and Jordan performed poorly with an average loss of 101 bps. High yield bonds performed better than high grade.

For the corporate sector, the CEMBI Broad Diversified (US dollar denominated, corporate, emerging market bonds) gained 5 bps due to spread related returns which were positive for this index while underlying US Treasuries lost 26 bps. Africa was the best performing region with a gain of 35 bps while Asia and Europe were the worst performers with a loss of 8 bps each. Metals and Mining was the best performing sector with a gain of 30 bps while Infrastructure was the worst with a 14 bps loss.

In the local currency markets, the JP Morgan GBI-EM Global Diversified index was down 26 bps in US dollar hedged terms last week. Currency returns were negative with the unhedged returns recording a higher loss of 155 bps. Middle East and Africa was the worst performing region with a loss of 67 bps, while Asia was the best one with a loss of 12 bps in hedged terms. Philippines and Turkey were the best performing countries with 18 and 4 bps gains respectively in US dollar hedged terms. The central bank in the Philippines noted that inflationary pressure, while rising, is not a concern yet and will adjust its policy as needed. In Turkey, the government is expecting inflation to end the year at 9.5% before dropping to 7% in 2018 according to the Medium Term Program. Malaysia and Uruguay were flat last week. On the laggard side, Argentina was the worst performer last week with a loss of 204 bps in US dollar hedged terms. The market remains edgy regarding the upcoming elections in Argentina despite recent polls in favor of the government coalition. However, latest data confirmed an improvement in fiscal profile with the YTD fiscal deficit in June at 1.9% of GDP. Romania and South Africa also performed poorly with 69 and 67 bps losses respectively in US dollar hedged terms. Accelerating core inflation in Romania prompted the market to conclude that the beginning of a tightening cycle is near. Inflationary pressures are also negatively affecting the South African market. Levels of consumer and business confidence remain low driven by the political tensions which should conclude with the ANC national conference in December, the conference will bring to an end Zuma's decade at the helm of the ruling party.

In FX markets, the Russian ruble was the only currency that performed well last week. The laggards were the Mexican peso, Chilean peso and Polish zloty.

The Funds
Our internal systems show that the MENA Bond Fund (MBF) was up by 9 bps last week to 29th September. The Bloomberg USD UAE Index was flat and the JP Morgan MECI (Middle East Composite) was also flat, so MBF was slightly better than the market. According to the 28th September NAV, MBF was up 3.79% year. The yield for MBF is 4.32%.

According to our internal systems the Sukuk Income Fund was up 4 bps in the week to 29th September. The JP Morgan MECI Sukuk was up 8 bps but the Dow Jones Global Sukuk Index was down 6 bps, so SIF was in line with the market. The 27th September NAV shows that SIF was up 1.93% year-to-date. The profit rate for SIF is 4.34%.

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