Macron and beyond

Weekly Fixed Income Comment – 08 May 2017

Overall Markets

Oil prices were obviously one of the headline grabbers last week as prices fell sharply during the early part of the week. Whilst the physical markets are important, especially in the long term, it still strikes us that the financial markets have been at least as important during this period. As we have written before, levels of oil (and downstream product) inventories remain a concern and point to the need for a renewed OPEC/ NOPEC agreement at the end of this month to keep the markets heading towards supply/ demand balance, but the overhang from speculative long positions and producer selling in the futures markets seems to have been major influences too. The good news is that over the last two weeks this overhang seems to have disappeared as longs have been stopped out and producers have stopped hedging future production at the lower price levels. Consequently, we are now more relaxed about oil prices than we have been recently.

Similarly, and as we’ve also noted before, since the US election there has been evidence of a significant short position in US Treasury futures that acted as one of the catalysts for the range trade/ rally that we have seen in that market this year. (A position that we underestimated, arguably). As with oil there has been further evidence in the last week that this position has been unwound further, with some measures indicating that participants in this part of the market are now long. This suggests that from here the economic data and the Fed will be main determinants of future moves.

As most of you would have seen, France now has President (elect) Macron. As there had seemed to be residual fears of a Le Pen victory this outcome should give risk assets, especially in Europe, a small boost over the next few days. It will be interesting to see how much of a boost, or not, risk assets and the euro gets, it is certainly interesting to see weakness as today (Monday) has gone on; we may be forced to revisit our thesis at some point. Nevertheless, all in all, a positive view about credits spreads and a somewhat more conservative approach to duration positioning seems to be reasonable still. It looks as if there could be a number of new issues ahead of Ramadan and we’ll pick our way through them.

Bond Funds & Mandates

In The Region
With US Treasury yields moving a bit higher last week and credit markets holding their own despite the commodity price developments, credit spreads were unchanged to tighter over the week. The OAS (option adjusted spread) for the Bloomberg Barclays UAE Index tightened from 138 bps to 128 bps. The spread for the JP Morgan MECI was flat at 225 bps. Consequently yields and profit rates were unchanged or slightly higher.

A number of PMIs came out around the region and indicated that the economies remain steady. The ENBD/ Markit PMI for the UAE was largely unchanged at 56.1 in April, for Saudi Arabia the PMI moved up slightly to 56.5 from 56.4. Further west, the Egyptian PMI moved up to 47.4 from 45.9 in March. Although still below 50, this was another in the series of improved readings since the lows of last October and November, and new export orders were up for the first time in nearly two years. In the same vein, the number of tourists visiting Egypt continues to move higher after the low point at the start of 2016. The IMF is conducting a standard review of Egypt as part of the facility that was granted last year and this should lead to the disbursement of the second part of the loan given that Egypt is hitting the targets that were set.

The IMF held a press conference about its view of the regional outlook last week but didn’t add anything of note to what emerged a few weeks ago in its Update. It is supportive of the fiscal measures implemented so far, sees budget deficits narrowing but said that further reforms are needed. Growth is seen as stable, albeit at lower levels due to oil prices and the production agreements.

Out of Region
The JP Morgan EMBI Global Diversified (US dollar denominated, sovereign, emerging market bonds) lost 14 bps last week. The underlying return from US Treasuries was the main detractor. All regions experienced a loss, Asia was the best performer with a 2 bps loss and Latin America was the worst performer with a loss of 29 bps. Cameroon, Trinidad and Tobago and Jamaica performed well with an average return of 1.14%. Venezuela, Mozambique and Iraq were the laggards with average loss of 2.21%. Venezuela was the outlier with a loss of 5.03% with the ongoing social unrest. High grade bonds performed better than high yield. For the corporate sector, the CEMBI Broad Diversified (US dollar denominated, corporate, emerging market bonds) recorded a gain of 6 bps driven by spread related returns. Latin America was the best performer with a 29 bps return while Asia was the worst performer with a loss of 6 bps. Telecom was the best performing sector with a 27 bps gain while Mining was the worst one with 30 bps loss. Turkish bonds and sukuk continued to trade well last week as the markets foresee a period of political calm after the recent dramas.

In local currency bond markets, the JP Morgan GBI-EM Global Diversified index was up 4 bps in US dollar hedged terms last week. Currency returns were also positive with the unhedged returns recording a 13 bps gain. Latin America was the best performing region with a 13 bps gain, while Middle East and Africa was the worst performing region with a loss of 22 bps. Czech Republic was the best performing country with an 88 bps gain in US dollar hedged terms as entry into the index continues to fuel demand for Czech bonds. However, local politics is another influence with a feud between the Prime and Finance Ministers. Brazil and Malaysia also performed well with 31 bps and 28 bps gains respectively in US dollar hedged terms. In Brazil, the government continues to implement its reform agenda with the latest being in the labour market, and inflationary pressure eased further with analysts reducing their forecast from 3.9% to 3.7% in 2017 and from 4.5% to 4.1% in 2018. In Malaysia, the bond market remains resilient despite uncertainties regarding capital flows with concerns regarding foreign reserves easing further with the latest data showing a level to finance 7.9 months of imports. Argentina was the worst performer last week with a loss of 37 bps in US dollar hedged terms. Investors remain worried about the position of the government regarding floundering companies, an automatic state bail out as expected under previous governments is not the favored option now. Russia and Chile also performed poorly with 43 bps and 36 bps losses respectively in US dollar hedged terms. Geopolitical issues continue to affect the Russian bond market despite an improving economy. Additionally, inflation surprised again on the down side at 4.1% in April, the 10th consecutive monthly drop.

In the FX markets, the Polish zloty, Hungarian forint and Romanian leu performed well last week. The laggards for the period were the Russian ruble, Mexican peso, and Peruvian sol.

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