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Weekly Fixed Income Comment – 07 August 2017

Overall Markets
In a largely uneventful week for our markets, the bookends of weak auto sales and solid non-farm payroll numbers in the US garnered quite a few headlines. We’ll use our old friend, the New York Fed Nowcast to summarise; they have now stopped updating their Q2 2017 number that stopped at 2.07%, and the last four weeks for their Q3 number have produced 1.84%, 1.95%, 1.92% and 1.98%.Bottom line in our view: growth of the US economy is pretty steady around 2% ! Over 5% revenue growth and 10% earnings growth in the current, US earnings season underscore this point. The Fed will probably start to unwind QE in September and the market is assigning a less than 50% probability to another rate hike this year.

Similarly, following the July rally, oil prices traded in a tight range last week with prices arguably right in the middle of the range that has persisted since Q2 2016. Most forecasts for the rest of this year remain bounded by this range. Doctor Copper also ranged last week but in doing so sustained the new highs at the Q2 2015 levels attained in July. Obviously, a weak US dollar is part of this story, with prices for these commodities in other currencies not doing so well recently given the dollar weakness.

All in all, a steady finish to the summer continues and remains a constructive backdrop for our universe of bonds and sukuk.

Bond Funds & Mandates

In The Region
MENA credit traded flat last week, spreads widening 1 to 2 bps. Most countries did see wider spreads but this was counterbalanced by the UAE that was flat, as indicated by the Bloomberg USD UAE index. Spreads for the broader MECI universe widened by 5 bps. The notable outperformer was the Iraqi market that tightened by 58 bps, as Iraq priced a highly regarded USD 1 billion, 6-year bond at 6.752% which was oversubscribed 6.6 times. On the geopolitical front, the conflict between Qatar and its neighbours remains deadlocked. Meanwhile, the Qatari cabinet approved a landmark, draft law that will grant permanent residency to certain foreigners that will also see them treated as Qatari citizens in a number of respects, such as education and healthcare services.

Earnings season is still ongoing. In the Banking sector, Dubai Islamic Bank and Emirates NBD Q2 2017 net profits rose by 14% and 6% respectively year-on -year. In Kuwait, Burgan Bank and National Bank of Kuwait Q2 net profits were respectively up by 23% and 11%, while Bank Muscat was down 14%. Notable laggards were in the Saudi cement sector with Saudi Cement, Yamama Cement and Yanbu Cement down 62%, 90% and 49% respectively. Overall results continue to be mixed, in keeping with the expected soft tone in Q2.

S&P affirmed Kuwait’s rating at AA with a stable outlook. According to the rating agency, “Kuwait’s large government and external net asset positions will continue to afford the authorities space to gradually consolidate government finances without weighing on growth. The stable outlook reflects the expectation that Kuwait’s public and external balance sheet backed by sizeable financial assets will remain strong over the forecast horizon, offsetting risk related to lower oil prices, undiversified economy, nascent parliament, and regional tensions.” Moody’s also reinstated an unsolicited Caa1 long-term issuer rating to Iraq after their successful USD 1 billion transaction. According to Moody’s, the rating, which is one notch below S&P and Fitch’s ratings, is due to the volatile growth, weak fiscal fundamentals and high event risk.

As the end of the summer holiday comes into sight, a number of potential issuers are apparently in discussions with banks about deals of various kinds. Those being talked about in the media include: Abu Dhabi's Senaat, a state-owned investor in the Emirate's industrial sector; Qatar National Bank, the Middle East’s largest lender; Abu Dhabi National Oil Company (ADNOC) about a project bond and loan; Oman, for about USD 2 billion this year to plug next year’s budget deficit; National Bank of Ras Al Khaimah.

Out of Region
The JP Morgan EMBI Global Diversified (US dollar denominated, sovereign, emerging market bonds) gained 54 bps last week. The spread related returns were the main contributors, with underlying US Treasuries adding a little too. Africa was the best performing region with a gain of 84 bps and Middle East was the lowest performer with a gain of 29 bps. Iraq, Venezuela and Gabon performed well with an average gain of 239 bps, while Costa Rica, Mozambique and Tanzania performed poorly with an average loss of 54 bps. Turkey also had a reasonable week. High yield bonds performed better than high grade.

For the corporate sector, the CEMBI Broad Diversified (US dollar denominated, corporate, emerging market bonds) gained 22 bps with balanced spread related and US Treasury related returns for this index. Asia was the best performer with a gain of 40 bps while Middle East was the worst performer with a loss of 40 bps. Transport was the best performing sector with a gain of 74 bps and Consumer was the worst with a 104 bps loss. Vedanta Resources from India successfully issued a 7-year bond that got some attention in this region, a final book of USD 1.7 billion facilitating the issuance of USD 1 billion of bonds at a yield of 6.125%.

In local currency markets, the JP Morgan GBI-EM Global Diversified index was up 11 bps in US dollar hedged terms last week. Currency returns were negative with the unhedged return recording a loss of 8 bps. Middle East and Africa was the worst performing region with a loss of 359 bps, while Asia was the best with a gain of 54 bps in hedged terms. Brazil was the best performing country with 120 bps gain in US dollar hedged terms; investors remain confident regarding the continuity of the reform program after the Congress rejected an attempt to try the President. Philippines and Uruguay also performed well with gains of 94 bps and 89 bps respectively in hedged terms. Public spending on infrastructure rose by 8.8% in 1H17 in the Philippines and a new tax package from the Senate is expected next month. In Uruguay, the latest data indicate that inflation resumed its downward trajectory, which started at the end of last year. South Africa was the worst performer last week with a loss of 359 bps in US dollar hedged terms. Economic concerns are deepening in South Africa with manufacturing activity dropping to an 8 year low. Mexico and Czech Republic also performed poorly with 68 bps and 39 bps losses respectively in US dollar hedged terms. Local and international politics continue to affect the Mexican bond market. The Czech central bank hiked the 2-week repo and lending rate by 20 and 25 bps respectively with an unchanged inflation outlook and an upward revision of GDP growth. Hence, investors remain edgy with a bullish macro outlook and hawkish tone.

In FX markets, the Philippine peso, Chilean peso and Colombia peso performed well last week. The laggards were the South African rand, Russian ruble and Mexican peso.

The Funds
Our internal systems show that the MENA Bond Fund (MBF) was up by 13 bps last week. The Bloomberg USD UAE Composite Index was up 9 bps, the broader JP Morgan MECI was down 9 bps. As per the 3rd August NAV, MBF was up by 3.31% year-to-date. The yield for MBF is 4.38%.

The Sukuk Income Fund (SIF) lost 1 bp over the week to the 4th August according to our internal systems. The Dow Jones Sukuk Index was up by 16 bps and the JP Morgan MECI Sukuk Index was up by 10 bps. According to the 2nd August NAV, SIF was down 2bp over the week and up 1.47% year-to-date. The profit rate for the fund is 4.45%.

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