Summer Is Setting In

Weekly Fixed Income Comment – 03 July 2017

Overall Markets
Arguably the most eye catching moves in the major markets last week were the rises in government bond yields, notably those of US Treasuries and Bunds, on the back of generally robust data and indications from the ECB, Fed and Bank of England officials that they are minded to decrease stimulus either through higher rates or reduced quantitative easing. None of this was particularly new or shocking but these markets were arguably vulnerable after the mid-May to mid-June rallies. The Fed clearly plans to start reducing the size of its balance sheet later this year and another rate hike remains a possibility.

As we noted last week, we have probably focused on growth (pretty strong) too much and not enough on inflation (low) this year against a backdrop of an oversold US Treasury market at the start of the year. But let’s not throw out the baby with the bath water. The lack of inflation despite growth is likely to contain the upward move in yields for now, but when the markets get somewhat overbought as they were a week ago then robust growth will also limit the downside in yields. In a quiet week this week (e.g. Independence Day in the US on Tuesday), Friday’s US non-farm payroll numbers will get the usual amount of attention, along with purchasing managers’ indices (PMIs) data in a number of countries.

A solid, albeit not startling rally in oil prices, over the last week seems to support the idea of an ongoing price range as we enter the third quarter, for all the usual reasons.

Bond Funds & Mandates

In The Region
With a lot of regional investors off for the first half of last week it was quiet but GCC bonds and sukuk traded reasonably well, supported by rebounding oil prices despite the Eid holiday and no resolution of the dispute between Qatar and the other GCC members. Credit spreads for UAE bonds tightened by 5 bps to 133 bps as indicated by the Bloomberg USD UAE Index. The broader JP Morgan MECI universe did better with spreads tightening by 7 bps. Nevertheless, prices were subdued as the spread narrowing was partially due to rising US Treasury yields, the 10-year US Treasury yield finished the week 16 bps higher at 2.30%.

Saudi Arabia, Egypt, UAE and Bahrain issued a list of 13 demands to Qatar, including closing the Al Jazeera television station and reducing ties to Iran as a prerequisite to end the ongoing dispute. The original deadline for compliance has been moved by 48 hours to the middle of this week. While pressures on the USD/QAR peg are mounting, Qatar’s Central Bankreaffirmed that "Qatari riyal's exchange rate is absolutely stable against the US dollar, and its exchangeability inside and outside Qatar is guaranteed at any time at the official price." Several UK banks stopped selling QAR. Qatar’s 5-year CDS reached an all-time high of 123 bps, up from 56 bps before the start of the diplomatic crisis.

In line with expectations of soft growth, Saudi Arabia’s Q1 GDP contracted by 0.5% on the back of lower oil prices and a contraction in the construction sector (-3.2% yoy). Inflation eased in the UAE as the consumer price index (CPI) decreased from 2.1% in May to 1.9% in June.

Saudi Arabia’s King Salman issued a royal decree replacing Crown Prince Mohammad bin Naif with the Deputy Crown Prince Mohammed bin Salman in a surprise move that puts Mohammed bin Salman as next in line to the throne. According to Fitch, “Saudi King Salman's decision to name his son Mohammed bin Salman as Crown Prince has reduced uncertainty about the royal succession and reduces the risk of slippage in the country's "Vision 2030" reform programme.” On the negative side, “the new Crown Prince has already made Saudi foreign policy less predictable and thus in the rating agency’s view, his promotion could raise tensions with Iran further.”

S&P affirmed Mubadala’s AA credit rating and IPIC’s A-credit rating with both companies outlooks maintained at stable. According to S&P,” the combined entity (MIC) will be seen as more strategically important to the government, providing greater economic value than as two distinctly separate entities; but also with combined assets of US$122 billion, both entities remain almost certain to receive financial assistance given their materiality and strategic importance.” Following a revision to Bahrain's outlook to negative, Fitch revised its outlook on Mumtalakat, Ahli United Bank, NBB and BBK to negative but their ratings were affirmed. Fitch also affirmed Oman’s BBB rating and revised down its outlook to negative. The rating agency mentioned Oman’s fiscal deficit of 21.4% of GDP in 2016 and an expected budget deficit of 11.9% of GDP 2017 as key drivers of the decision.

Elsewhere in the region, Egypt’s economy remains on the right path.The Central Bank announced being ahead of its target to raise foreign reserves by USD 5 billion by the end of the current fiscal year.Additionally, the country hiked its fuel price by 50% last week in order to meet the terms of the USD 12 billion deal with the IMF. Fitch affirmed Egypt's B credit rating with a stable outlook. According to Fitch, “Egypt's ratings balance a large fiscal deficit, a high general government debt/GDP ratio and recent volatile political history, with renewed progress in implementing an economic and fiscal reform programme and improving external finances.”

Nothing is imminent in the primary market.

Out of Region
The JP Morgan EMBI Global Diversified (US dollar denominated, sovereign, emerging market bonds) lost 39 bps last week. US Treasuries were the main drain. On a regional basis, Middle East was the worst performer with a 60 bps loss and Africa was the best performer with a loss of 7 bps. While Venezuela, Ecuador and Cameroon performed well with an average return of 168 bps, Argentina, Mozambique and Mongolia were the laggards with an average loss of 134 bps. High yield bonds performed better than high grade ones. For the corporate sector, the CEMBI Broad Diversified (US dollar denominated, corporate, emerging market bonds) also recorded a loss of 6 bps also driven by Treasuries. Latin America was the best performer with a gain of 12 bps return while Asia was the worst performer with a loss of 23 bps. Pulp and Paper was the best performing sector with a gain of 14 bps gain, Real Estate was the worst one with a loss of 30 bps.

In local currencies, the JP Morgan GBI-EM Global Diversified index lost 31 bps in US dollar hedged terms last week. Currency returns were slightly positive with the unhedged returns recording a lower 19 bps loss. Asia was the best performing region with a loss of 15 bps, while Middle East and Africa was the worst one with a loss of 174 bps. Argentina was the best performing country with a 75 bps gain in US dollar hedged terms. The recovery of the Argentinian economy seems to be back on track with the government pushing forward with its reform agenda, job creation is accelerating although it is running well below the highs of 2011. Philippines and Brazil also performed well with 52 bps and 35 bps gains respectively in US dollar hedged terms. Economic growth in the Philippines has held up well relative to peers. However, a buildup in inflationary pressures driven by administrative costs remains a concern. In Brazil, while the everlasting political saga continues to evolve, the National Monetary Committee announced a 4.25% inflation target for 2019 and 4.0% for 2020. These targets are lower than the current 4.5% for 2017 and 2018. This will allow a gradual convergence towards the ideal, 3% target. On the laggard side, South Africa was the worst performer last week with a loss of 174 bps in US dollar hedged terms. The leadership crisis continues to affect negatively South African market. The ANC also needs to address a 28% unemployment rate, combined with credit rating downgrades. Mexico and Romania also performed poorly with 82 bps and 52 bps losses respectively in US dollar hedged terms. Unsurprisingly, Banxico hiked its policy rate by 25bp to 7% last week. While analysts are not expecting further hikes, inflation has not started to fall yet. In Romania, where the Prime Minister was ousted by his own party, the market was jittery with news that the government is about to dismantle the second-pillar pension system.

In FX markets, the Hungarian forint, Romania leu and Polish zloty performed well last week. The laggards were the South African rand, Colombia peso and Mexican peso.

The Funds
Our internal systems show that the MENA Bond Fund (MBF) was down by 0.14% last week to June 30th. The Bloomberg UAE Index was down by 0.10% whilst the JP Morgan MECI and the JP Morgan MECI GCC indices were down by 0.16% and 0.10% respectively, so MBF’s performance was in line with the broad market. According to the 29th June NAV, MBF was up 2.53% year to date. The yield on MBF is 4.30%, duration is 3.09, volatility is 1.74%.

The Sukuk Income Fund (SIF) was down by 0.08% last week to Friday 30th June.Indices returns were mixed, the JP Morgan MECI Sukuk Index was up by 0.01% and the Dow Jones Sukuk Index was down by 0.18%. According to the 28th June NAV, SIF was up by 1.23% year to date.The profit rate for SIF is 4.32%, duration is 3.29, volatility is 1.73%.

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