Seventh Innings

Weekly Fixed Income Comment – 06 November 2017

Overall Markets

Into the seventh innings. Broadly speaking there have been six phases in the progress of the (MENA) credit markets this year. The shortest rally, in January and February, was followed by the shortest sell-off in the first half of March. From mid-March to the end of May we had the longest rally, followed by a sell-off into early July. The subsequent rally until early September has been followed by slightly softer to sideways market to date.

Breaking these down further:

  • The January rally was dominated by the further compression of credit spreads that continued the tightening seen in 2016 following the earlier oil and commodity price driven spread widening of 2015;
  • The short sell-off in March was due the last peak in US Treasury yields that followed the Trump election victory, yields have not reached these levels since except for short-dated Treasuries;
  • The longest rally in the spring was driven by lower US Treasury yields and stable credit spreads;
  •  In early June, growth concerns were part of the reason for wider credit spreads with somewhat higher Treasury yields then adding to the sell-off in late June and early July;
  • The July to September rally was dominated by falling US Treasury yields again, with credit spreads initially stable but then widening as credit markets were unable to keep up with the Treasury market rally;
  • Since then we have seen the opposite with Treasury yields rising but credit markets holding in such that spreads have tightened.

Viewing this from 30,000 feet, the good returns from (MENA) credit this year have been the result of stable credit spreads (after the bonus of tightening in January and February) on top of a ranging US Treasury market, with the phases mainly being driven by underlying US Treasuries after that spread dominated phase at the start of the year.

If this view from 30,000 feet is still a good vantage point, we need to answer the two related questions to gauge the foreseeable future: what will credit spreads do and what will Treasury yields do ? Maybe we could also ask – and how quickly ? As credit spreads are a risk asset and as growth remains supportive of risk assets, we remain constructive about overall credit spreads, whilst acknowledging that growth will look better at some times than others. Whether they continue to trade in a range or tighten further is a somewhat moot point. Unless this view about growth is way off the mark, it seems likely that US Treasury yields will move somewhat higher or continue to trade in a range, depending on maturity. Inflation remains a puzzle for many market participants but as long as there is a lack of it, the Fed under the current and next leadership seems set to follow its usual framework and thus only hike rates slowly, and breakeven inflation rates will not go up meaningfully. One of the questions we have about this view is whether financial conditions become more important to the market, in other words will the Fed and markets see higher rates as acceptable or necessary if equity markets continue to rally ?

A last consideration, for now, the US dollar. Dollar weakness this year has been an integral part of the story. Good growth around the globe and valuation suggests that the recent dollar strength is a correction rather than renewed upturn, the dollar has been strong against many currencies but not all. This suggests that a range may well lie ahead and would be fine for many.

Bond Funds & Mandates

In The Region
MENA credit had a positive return last week, yields and returns were helped by a rally in underlying US Treasuries with limited moves for credit spreads. For the Bloomberg UAE index spreads widened by 4 bps to 117 bps, for the broader JP Morgan MECI universe spreads tightened by 1 bp to 232 bps. Iraq was the best performer with a 206 bps gain, Bahrain was the worst with a gain of 3 bps. In the GCC, Saudi Arabia performed well with a gain of 70 bps followed by Oman at 69 bps. Sukuk recorded gains of 11 bps. Corporates fared worse than sovereigns and quasi-s with a loss of 27 bps.

Fitch affirmed Saudi Arabia’s A+ rating with a stable outlook. The rating agency said that Saudi Arabia’s ratings are supported by strong fiscal and external balance sheets, including exceptionally high international reserves, low government debt, significant government assets and strong commitment to an ambitious reform agenda. Saudi GDP is expected to contract by 0.4% this year. However, the rating agency expects GDP growth to increase to 0.8% in 2018, and 1.3% in 2019. Further out the proceeds of the 5% stake in Aramco should help diversify the economy. Separately, the country has decided to push back the balanced budget goal to 2023 from 2020. The deficit reached a record USD 98 billion in 2015. Currently, the market is closely following the anti-corruption drive that started at the weekend, wondering about how much is economics and how much is politics, and about the short-term and longer-term implications. For now, there is a degree of uncertainty.

The Emirates NBD Purchasing Managers’ Index (PMI) for the UAE rose to 55.9 in October from 55.1, marking a strong start for the last quarter of the year. The output index reached 60.5 and the new orders index was recorded at 59.9 driven by new export orders. These numbers reflect strong demand due to promotional activities and discounts, seen in reduced selling prices.  

With its foreign reserves at a low level, Bahrain asked Gulf allies for financial assistance to avoid currency devaluation and further financial issues. The  request  was  made to the key major economies of the region, Saudi  Arabia, the  UAE and Kuwait. While markets expect the countries to agree, conditions will be required.

As expected, Dana Gas did not pay its investors when the two mudaraba sukuk worth a total of USD 700 million matured on 31st October. The next leg of the court cases in the UAE and UK is due in mid-November, in the UK relating to the request to get the UAE’s court injunction lifted.

Last week, issuance was dominated by Mazoon Electricity Company which is the largest electricity distribution company in Oman as they issued USD 500 million of a 10-year sukuk at mid-swaps + 287 bps. It was yet another issue that was heavily oversubscribed and that traded up in the secondary market. Emirates NBD Bank is preparing for a 5-year, senior bond this week.

Out of Region
The JP Morgan EMBI Global Diversified (US dollar denominated, sovereign, emerging market bonds) gained 14 bps last week. The gains were due to underlying US Treasuries which made 54 bps, with Treasuries rallying (lower yields) credit spreads widened and spread related returns lost 40 bps. Africa was the best performing region with a gain of 108 bps (Zambia did well in this space) and Latin America was the worst with a loss of 30 bps. Egypt, Gabon and Angola performed well with an average gain of 178 bps, while Venezuela, Turkey and Mozambique performed poorly with an average loss of 814 bps. Venezuela was an outlier with a loss of 23.54%. The Venezuelan President announced that the state-owned oil company will seek to restructure its debt. Turkish sovereign bonds lost money as noted here but there were gains for corporates, so mixed performances. High grade bonds performed better than high yield.

For the corporate sector, the CEMBI Broad Diversified (US dollar denominated, corporate, emerging market bonds) gained 19 bps, US Treasury related returns were plus 36 bps while spread related returns were minus 17 bps. Africa was the best performing region with a gain of 49 bps while Middle East was the worst performer with a loss of 27 bps. Metals and Mining was the best performing sector with a gain of 51 bps, Consumer was the worst with a 68 bps loss.

In the local currency markets, the JP Morgan GBI-EM Global Diversified index was down 7 bps in US dollar hedged terms last week. Currency returns were also negative again, as the US dollar continued to recover against a number of currencies, with the unhedged returns recording a higher loss of 36 bps. Middle East and Africa was the worst performing region with a loss of 71 bps, while Asia was the best one with a gain of 62 bps in hedged terms and also gained in unhedged terms as Asian currencies were firm. Indonesia was the best performing country with 134 bps gain in US dollar hedged terms. The market reacted positively to the new budget with a lower budget deficit at 2.2% of GDP; infrastructure and education remain key priorities for spending. Czech Republic and Peru also performed well with 28 and 26 bps gains respectively in US dollar hedged terms. Despite an interest rate hike, the Czech bond market reacted positively to the new forecast confirming a measured pace of rate rises going forwards. In Peru, inflation continues to surprise on the downside as headline CPI dropped by 0.47% in October driven by food prices. Turkey was the worst performer last week with a loss of 129 bps in US dollar hedged terms, and more in unhedged terms. Adding to political issues, inflation in Turkey reached its highest level since January 2014 at 11.9%. The marked deterioration kept the market on edge and brought questions about the central bank’s gradual approach. South Africa and Brazil also performed poorly with 71 and 65 bps losses respectively in US dollar hedged terms. The medium term budget brought more uncertainties for the South African economy. Additional revenue measures expected in February 2018 will be influenced by the December 2017 ANC elections. In Brazil, the political saga continues to negatively impact the reform agenda, although the latest data indicated that the government deficit improved in September driven by a surplus from regional governments and state owned enterprises.

In FX markets, the Indonesia rupiah, Thai baht and Romania leu performed well last week. The laggards were the Turkish lira, Brazilian real and Russian ruble.

The Funds
Our internal systems show that MENA Bond Fund (MBF) was up 36 bps last week to 3rd November. The Bloomberg USD UAE Index was up 14 bps and the JP Morgan MECI (Middle East Composite) was up 19 bps, so MBF was ahead of the market. According to the 2nd November NAV, MBF was up 4.23% year-to-date. The yield of MBF is 4.27%.

According to our internal systems the Sukuk Income Fund (SIF) was up 2 bps in the week to 3rd November. The JP Morgan MECI Sukuk was up 11 bps and the Dow Jones Global Sukuk Index was up 20 bps, so SIF was behind the market. The 1st November NAV shows that SIF was up 1.92% year-to-date. The profit rate for SIF is 4.42%.

Disclaimer: To the fullest extent allowed by applicable laws and regulations, National Bank of Abu Dhabi PJSC (the “Bank”) and any other affiliate or subsidiary of the Bank, expressly disclaim all warranties and representations in respect of this communication. The content is confidential and is provided for your information purposes only on an “as is” and “as available” basis and no liability is accepted for or representation is made by the Bank in respect of the quality, completeness or accuracy of the information and the Bank has undertaken no independent verification in relation thereto nor is it under any duty to do so whether prepared in part or in full by the Bank or any third party. Furthermore, the Bank shall be under no obligation to provide you with any change or update in relation to said content. It is not intended for distribution to retail investors or retail clients and is not intended to be relied upon as advice; whether financial, legal, tax or otherwise. To the extent that you deem necessary to obtain such advice, you should consult with your independent advisors. Any content has been prepared by personnel of the Global Asset Management division at the Bank and does not reflect the views of the Bank as a whole or other personnel of the Bank. NBAD is licensed by the Central Bank of the UAE.