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Weekly Fixed Income Comment – 09 October 2017

Overall Markets

Amongst the time honoured tasks of a portfolio manager, the quarterly report is firmly on the list. The review of the last 3 months and a look ahead to the next 3. Normally seen as an important but less than thrilling task, this particular mode of reflection does occasionally put things in a different perspective from when you were living through the period day to day. Without wishing to overstate the magnitude of the insights gleaned from our recent reflections on Q3, writing the latest quarterlies was interesting nonetheless.

With a focus on the US Treasury market, the steady rally of bonds in July and August fitted with a narrative of softer data and uncertain Fed, and the spike down towards 2% for 10-year bonds fitted with the narrative of North Korea to some extent; a bid for risk free or safe haven assets. However, the data didn’t really soften that much (not that we had thought it was much softer at the time), equity markets had the slightest of sell-offs in August, the US dollar the slightest of rallies and perceptions of inflation in the US (as measured by breakeven inflation rates) moved up over the period with only a slight dip in August. Viewed from this perspective there was an overreaction to the data and more headlines about North Korea than market reaction. With growth data picking up again, fiscal policy back on the agenda as discussed last week and a certain amount of ennui surrounding North Korea, the start of Q4 looks as market friendly as much of the rest of 2017 has been.

Obviously it has been a friendly year for credit markets in the fixed income universe, including MENA bonds and sukuk. The accompanying, investor bid for fixed income has been evident in mutual fund flow data and in oversubscriptions for new issues. The recent MENA issuance suggests this bid remains firmly in place: a USD 15 billion book for what ended up being USD 3 billion of issuance by Bahrain, a book of over USD 4 billion for the USD 1 billion Jordan deal and a book of over USD 30 billion for Abu Dhabi’s 10 billion of issuance. Even allowing for the games that are played during the book building process, this suggests good demand still.

It’s a quiet week for data this week. The latest Fed minutes get released on Wednesday and we may hear more from the Dana Gas sukuk court case in London on Thursday.

Bond Funds & Mandates

In The Region
MENA credit spreads tightened a little last week with Oman and Jordan being outperformers. New sovereign issues dominated the market again. After the earlier Bahrain and Saudi Arabian issues, Jordan priced a USD 1 billion 30-year bond and Abu Dhabi (ADGB) issued USD 10 billion with the book in excess of USD 30 billion. Except for the long-dated Abu Dhabi bond, most new issues rallied at the end of the week.

The IMF released a series of reports on the Saudi Arabian economy.While recognising the bold reform program under vision 2030, the IMF identified uncertainties driven by oil prices and the real impact of the reforms on the economy and recommend that the fiscal framework should be strengthened to support the implementation of the reforms. Inflation is expected to increase due to the implementation of VAT and additional reforms on energy prices/ subsidies.

Staying in Saudi Arabia, insurance companies must reach 100% Saudization by February 1st, 2018 according to the latest directive from SAMA. This means that non-Saudis are prohibited from selling or marketing insurance products to individuals. This new directive is in addition to an earlier one that made it compulsory to Saudize all jobs related to vehicles claims management, customer service and dealing with complaints in all branches of insurance companies.

The budget deficit in Oman was down 32% to OMR 2.5 billion in the first seven months of 2017, compared to 3.7 billion riyals of the same period in 2016 according to the National Centre for Statistics and Information. Oman posted a budget deficit of 5.3 billion riyals in 2016, as revenues declined by more than 30%. Oman is expected to issue a new bond by the end of the year.

In Qatar, the regional boycott continues to negatively affect the economy. The latest news indicates that the Qatari government is planning to tap the bond market with large new issues.According to Moody’s, Qatar spent USD 40 billion in the first 2 months of the standoff to support its economy and financial sector. Recent data from the central bank indicated that the non-resident deposits declined from QAR 185 billion (USD 51 billion) in May 2017 to QAR 149 billion (USD 41 billion) in August 2017 – a net outflow of USD 10 billion, with further falls in other liabilities.

In the UAE, Dubai September whole economy PMI dropped to 55.2 from 56.3 in August. While the reading is in line with last year’s number at 55.1, it is the lowest reading for 5 months. Furthermore, a recent survey from Oxford Economics indicates real salary growth will be 2.9%, down from 3.6% in 2016. Higher livings cost will put further pressures on real earnings.

Egypt was reported as saying they may delay their planned sale of 1.5 billion in euro denominated bonds to early 2018. Aside from the sovereigns noted above, the primary markets remains quieter than expected. Oman is expected to issue at any time.

Out of Region
The JP Morgan EMBI Global Diversified (US dollar denominated, sovereign, emerging market bonds) gained 6 bps last week. The return from underlying US Treasuries was negative 25 bps, the return from credit spread related factors was 31 bps. Africa was the best performing region with a gain of 33 bps and Latin America was the worst with a loss of 3 bps. Ecuador, Angola and Venezuela performed well with an average gain of 122 bps, while Mexico, Iraq and Colombia performed poorly with an average loss of 57 bps. High yield bonds performed better than high grade, as expected given that it was spread related returns that were positive.

For the corporate sector, the CEMBI Broad Diversified (US dollar denominated, corporate, emerging market bonds) gained 9 bps, spread related returns were 25 bps for this index while the US Treasury component lost 16 bps. Africa was the best performing region with a gain of 54 bps while Middle East was the worst performer with a loss of 15 bps. Metals and Mining was the best performing sector with a gain of 59 bps while Consumer was the worst with a 39 bps loss.

In the local currency markets, the JP Morgan GBI-EM Global Diversified index down 30 bps in US dollar hedged terms last week. Currency returns were also negative with the unhedged returns recording a higher loss of 103 bps, with the US dollar continuing to strengthen. Middle East and Africa was the worst performing region with a loss of 83 bps, while Asia was the best with a loss of 9 bps in hedged terms. Argentina was the best performing country with a 211 bps gain in US dollar hedged terms. The average inflation of the past 4 months dropped to 18.2% compared to 21% for the past 14 months. However, the market remains skeptical on the credibility of the central bank. Peru and Russia also performed well with 37 and 17 bps gains respectively in US dollar hedged terms. In Peru, the latest inflation data points to a slight deflation with annual inflation down to 2.9% in September from 3.2% in August due to falling prices of food and beverages. The resilience of the domestic demand in Russia was confirmed with GDP growth for Q2 of 2.5%. Mexico was the worst performer last week with a loss of 99 bps in US dollar hedged terms. Domestic demand is slowing and investment is falling due to reduced public infrastructure spending. However, inflation is showing signs of easing. Czech Republic and South Africa also performed poorly with 92 and 83 bps losses respectively in US dollar hedged terms. Inflation is also centre stage in the Czech Republic with energy costs being the main factor. The annual inflation rate is expected to rise to 2.7% in September from 2.5% in August. The probability of rating downgrades is edging higher with recent news flow. Furthermore, the authorities should address growing challenges at state-owned entities with the upcoming medium term budget policy statement.

In FX markets, the Chilean peso, Colombian peso and Brazilian real performed well last week. The laggards were the Mexican peso, South African peso and Turkish lira.

In Turkey, Türkiye Petrol Rafinerileri (TUPRAS) is on the road to raise money and should come with a 10-year issue in USD.

The Funds
Our internal systems show that MENA Bond Fund (MBF) was up 11 bps last week to 6th October. The Bloomberg USD UAE Index was down 8 bps and the JP Morgan MECI (Middle East Composite) was down 13 bps, so MBF was slightly better than the market. According to the 4th October NAV, MBF was up 4.02% year-to-date. MBF has a yield of 4.24%.

According to our internal systems the Sukuk Income Fund (SIF) was down 1 bp in the week to 6th October. The JP Morgan MECI Sukuk was up 2 bps and the Dow Jones Global Sukuk Index was up 17 bps, so SIF was a little behind the market. The 4th October NAV shows that SIF was up 1.99% year-to-date. The profit rate for SIF is 4.28%.

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