Steady As She Goes, In Most Places

Weekly Fixed Income Comment – 13 June 2017

Overall Markets

Qatar has obviously dominated the news in the region and has also made international headlines. Away from this the news has generally been less dramatic and for global, financial markets of the steady as she goes variety. Growth data has steadied in the US and China after some earlier softening, while Europe, Japan and other parts of the world continue to be in good shape from a cyclical perspective. In the US, second quarter growth looks to be somewhere above 2%. Away from the mess in the UK, European politics has headed for calmer waters rendering the fears at the start of 2017 redundant. Macron has dominated the French elections and the Five Star party in Italy has suffered at the polls; the populists are in retreat for now.

Geopolitics in the region have not impacted the oil price, which has softened again apparently still under pressure from the ongoing, high inventory levels for both crude and downstream products.

One of the key focal points this week will be Wednesday’s Fed meeting in the US. A hike is inevitable so the real interest will be on what Chair Yellen says and any changes in the governors’ forecasts.

Bond Funds & Mandates

In The Region
MENA bonds and sukuk were on the back foot last week, as the political developments surrounding Qatar dominated the news and the severity of the crisis remained unclear. Credit spreads for UAE bonds widened by 2 bps to 134 bps as indicated by the Bloomberg USD UAE Index. The broader JP Morgan MECI universe did worse with spreads widening by 7 bps. The primary market was muted.

It was light in terms of GCC, macroeconomic data. Inflation edged up in Oman as the consumer price index (CPI) increased from 1.79% in April to 1.96% in May led by a rise in transportation costs. UAE’s economy still seems to be growing at a reasonable pace although the Dubai Economy Tracker eased from its two year high of 57.7 in April to 55.0 in May, new orders increased in the construction sector as Expo 2020 preparations are moving ahead.

The markets’ main focus was Qatar last week and the rating agencies were monitoring the situation. S&P lowered Qatar’s credit rating from AA to AA- and placed the rating on credit watch with negative implications, adding that it will review “the potential impact on our projections as further details emerge” at its next scheduled review on 25th August 2017. S&P mentioned that GCC funding represents less than 10% of Qatar’s banks external funding. According to Fitch, the duration of the diplomatic dispute and the scope of the measures that affect trade will be key in assessing the level of damage to Qatar’s economy, “Sovereign net foreign assets worth over 200% of GDP mean that the sovereign credit profile is highly resilient to external shocks. As the situation evolves, our assessment will focus on effects on the sovereign's external and fiscal deficits.” According to Moody’s, "a prolonged or deepening rift between Qatar and its GCC neighbors would potentially have a more marked financial effect and increase funding costs for the sovereign and other Qatari entities."

Meanwhile, Saudi Arabian banks have been told not to increase their exposure to Qatari clients and not to process any payments in QAR. Following those measures, the Central Bank of Qatar declared it will provide liquidity if requested as its currency came under strong pressure. There were mixed flows from Asian, European and US investors in this environment with regional investors either on the sidelines or being defensive.

Out of Region
The JP Morgan EMBI Global Diversified (US dollar denominated, sovereign, emerging market bonds) gained 17 bps last week. Return was driven by spread as underlying US Treasury returns were negative. On a regional basis, Europe was the best performer with a 26 bps gain and Middle East was the worst performer with a loss of 79 bps, not surprisingly given the political issues. While Dominican Republic, Mexico and Ghana performed well with an average return of 122 bps, Venezuela, Oman and Belize were the laggards with an average loss of 267 bps. High grade bonds performed better than high yield ones.  For the corporate sector, the CEMBI Broad Diversified (US dollar denominated, corporate, emerging market bonds) was flat with only spread related returns being positive. Africa was the best performer with a gain of 18 bps while Middle East was the worst performer with a loss of 63 bps. Metals and Mining was the best performing sector with a 27 bps gain while Financials was the worst one with 10 bps loss.

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 returns recording a 3 bps gain. Latin America was the best performing region with a gain of 52 bps, while Middle East and Africa was the worst one with a loss of 58 bps. Argentina was the best performing country with a 137 bps gain in US dollar hedged terms. After recording higher than expected inflation in February-April, inflation pressures finally show signs of subsiding in May as CPI rose by 1.3% in May, bringing annual inflation down to 24% from 27.5% in April. Mexico and Brazil also performed well with 109 bps and 60 bps gains respectively in US dollar hedged terms. Mexican bonds benefited from the U.S.-Mexico agreement in principle on sugar trade, further reducing the negative sentiment towards Mexico. Additionally, there are signs that inflation pressures may be ebbing. In Brazil, the market rallied after the Superior Electoral Court voted against the annulment of 2014 winning presidential ticket. Hence, Temer remains as President. Turkey was the worst performer last week with a loss of 63 bps in US dollar hedged terms, as the Middle East crisis spilt over to Turkey when it decided to station troops at a base in Qatar. Furthermore, inflation remains a concern. South Africa and Czech Republic also performed poorly with 58 bps and 48 bps losses respectively in US dollar hedged terms. The latest GDP data confirmed that South Africa’s economy entered a technical recession for the first time since 2009. Rating pressures continue to loom with fading expectations of any decisive actions from the government.

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

The Funds
Our internal systems show that the MENA Bond Fund (MBF) was down by 0.64% last week to June 9th. The Bloomberg UAE Index was down by 0.19% whilst the JP Morgan MECI and the JP Morgan MECI GCC indices were down by 0.67% and 0.86% respectively, so MBF’s performance was slightly  better than the broad market. According to the 8th June NAV, MBF was up 2.57% year to date. The yield on MBF is 4.46%, duration is 3.35, volatility is 2.00%.

Our internal systems show that the Sukuk Income Fund (SIF) was down by 0.71% last week to Friday 9th June. Indices were down too, the JP Morgan MECI Sukuk Index and the Dow Jones Sukuk Index were down by 0.45% and 0.29% respectively. According to the 7th June NAV, SIF was up by 1.58% year to date, meaning that the NAV was down by 0.37% over the week. The profit rate for SIF is 4.40%, duration is 3.45, volatility is 1.89%.

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