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A Quieter Start

Weekly Fixed Income Comment – 13 November 2017

Overall Markets

So now we know how the seventh innings started: on a soft note. The regional news centring on Saudi Arabia obviously had an impact on our markets last week but was also a factor in the weaker credit markets that we saw globally, along with focal points in the US high yield markets centred on some of the companies in that universe and outflows from the big ETFs.

So, in similar vein to last week, we could ask what might be the key questions posed by these fundamental and markets events. First, is this the start of a period of seasonal weakness that some commentators have pointed to over the last 3 years ? Second, and related to the first, have we seen generalized or specific weakness ? Whilst there are arguments for seasonal weakness to persist, there are others that point in the other direction that carry more weight in our view.

This has been a good year for credit and emerging markets, in the region and globally, such that traders and investors may well look to protect performance going in to year end. However, in the last few years regional credit markets had to contend with falling oil prices in 2014 and 2015, and the US election result (rising US yields and dollar) in 2016. This year we have a strong oil prices at the moment and good, global growth that is keeping the dollar in check. Although we have seen classic, credit market weakness in the last few weeks with credit spreads widening globally and steeper credit curves (i.e. spreads for low rated bonds widening more than those for high rated bonds), again we are drawn to some of the specifics: Saudi Arabia and Lebanon, and certain high yield issuers in the US. Certainly there was a broad, risk-off tone last week with nearly all equity markets down too but both the prior rally and the sell-off do not appear climactic. Of course, as Saudi Arabia has demonstrated there are always unknown unknowns, but absent these a steadier finish to the year appears most likely.

Bond Funds & Mandates

In The Region
MENA credit had a negative return last week. The JP Morgan MECI index was down 143 bps, credit spreads widened by 17 bps, UAE was the best performer with a 37 bps loss while Lebanon was the worst with a loss of 651 bps. In the GCC, Saudi Arabia performed poorly with a loss of 209 bps followed by Bahrain at 193 bps. The ongoing, anti-corruption drive in Saudi Arabia negatively affected the regional markets. Sukuk recorded a loss of 71 bps and sovereign bonds were the main drain with a loss of 203 bps.

The anti-corruption drive in Saudi Arabia and the resignation of Lebanese, Prime Minister Hariri continued to be developing stories last week. More arrests were made in Saudi Arabia and there was ongoing debate about the real intentions and plans of MBS with respect to both domestic and regional/ external issues (i.e. Iran). Whilst many laud the apparent intention to improve the way business is done, the latest actions of the Crown Prince obviously threaten the consensus amongst the Saudi royal family and raise questions for foreign investors regarding stable partnerships and stability more broadly. Developments in the coming days and weeks will be closely watched both inside and outside the region, with the potential Arab League meeting.

Oman was cut to BB from BB+ by S&P with a stable outlook. The rating agency cited large twin deficits financed mainly through external borrowing. Further, the rating agency noted that Oman’s economy remains heavily reliant on the hydrocarbons sector in spite of attempts to diversify revenue streams via the development of other sectors including tourism and logistics. Monetary policy tools remain limited due to the currency being pegged to the US dollar. Oman now has ratings that stretch from BB to BBB (Moody’s & Fitch).

Bank ratings from Fitch are marginally down over the past year and one third are on negative outlook. The rating agency noted that the ability of Qatar and Saudi Arabia to provide support for the banking system has diminished due to lower oil prices and regional diplomatic issues. However, sovereign willingness to provide support remains extremely strong. Looking further at the issuer default rating of most GCC banks, 77% are driven by potential sovereign support, 19% by banks’ standalone creditworthiness, the remaining 4% by potential, parent support.

The IMF has reached a staff level agreement to disburse a USD 2 billion loan after a review of Egypt’s economic reforms last week. Once this latest USD 2 billion tranche has been disbursed, the IMF will have awarded USD 6 billion under the 3-year programme which started in 2016 under IMF conditions. According to the IMF, Egypt’s economy continues to perform strongly and reforms that have already been implemented are beginning to pay off in terms of macroeconomic stabilization and the return of confidence. S&P affirmed its B- rating for Egypt with a positive outlook.

In the UAE, the Cabinet approved a federal budget of USD 54.7 billion for the years 2018-2021, of which 25.4% or USD 13.9 billion relates to 2018 with no deficit forecast. The largest portion of the 2018 budget has been earmarked for ‎social development and social benefits at 43.5%; education and health are the key sectors. The Cabinet also confirmed the implementation of the VAT for January 2018.

Last week, Emirates NBD issued a 5-year USD 750 million bond at mid-swaps +125 bps. Omantel is planning USD 1.4 billion debut sukuk sale in order to support their recent acquisition of an increased stake in Kuwait’s Zain, according to the CEO. Emirates Sembcorp Water & Power Co., owner of the Fujairah F1 power and desalination plant, is on the road planning to issue USD 400 million bond, with an average life of 18 years.

Out of Region
The JP Morgan EMBI Global Diversified (US dollar denominated, sovereign, emerging market bonds) lost 80 bps last week. Credit spread related returns lost 45 bps, as spreads widened, whilst the return from underlying US Treasuries was a loss of 35 bps. Middle East was the worst performing region with a loss of 365 bps (Lebanon being key) and Europe was the best one with a loss of 34 bps. El Salvador, Latvia and Serbia performed well with an average gain of 3 bps, while Lebanon, Belize and Jordan performed poorly with an average loss of 357 bps. Lebanon was an outlier with a loss of 625 bps after the surprise resignation of the Prime Minister. High grade bonds performed better than high yield, in what was a classic week of spread curve steepening.

For the corporate sector, the CEMBI Broad Diversified (US dollar denominated, corporate, emerging market bonds) lost 45 bps. Underlying US Treasuries lost 24 bps while spread related returns lost 21 bps. Europe was the best performing region with a loss of 16 bps while Middle East was the worst with a loss of 88 bps, Saudi Arabian corporates being key here. Transport was the best performing sector with a loss of 7 bps, Consumer was the worst with an 89 bps loss.

In the local currency markets, the JP Morgan GBI-EM Global Diversified index was down 10 bps in US dollar hedged terms last week. Currency returns were positive with the unhedged returns recording a gain of 46 bps. Middle East and Africa was the worst performing region with a loss of 35 bps, while Latin America was the best one with a loss of 6 bps in hedged terms. Peru was the best performing country with 64 bps gain in US dollar hedged terms. The central bank delivered a 25 bps rate cut last week on the back of the low inflation print recorded last month in Peru. Poland and Hungary also performed well with 45 and 32 bps gains respectively in US dollar hedged terms. The Polish government is expecting a deficit below 3% in 2018. The impact of the bill for FX mortgage relief on banking sector has yet to be finalized. Fitch affirmed Hungary’s outlook at positive, with BBB- rating, due to marked improvement in net external debt. This year’s decline in government debt marked its sixth consecutive year of decline. On the laggard side, Argentina was the worst performer last week with a loss of 227 bps in US dollar hedged terms, as markets continue to question Argentina’s ability to successfully implement the required reforms. The IMF expects more private investments following their article VI review. Romania and Czech Republic also performed poorly with 64 and 56 bps losses respectively in US dollar hedged terms. Latest economic data showed that inflation in Romania is above the central bank’s 2.5% target, the highest level in four years. In Czech Republic, inflation was also at the centre of investors’ concerns as inflation accelerated in October to 2.9%, close to the 3% upper limit, driven by food costs.

In FX markets, the Colombian peso, Malaysian ringgit and Polish zloty performed well last week. The laggards were the South African rand, Romania leu and Russian ruble.

The Funds
Our internal systems show that MENA Bond Fund (MBF) was down 54 bps last week to 10th November. The Bloomberg USD UAE Index was down 32 bps and the JP Morgan MECI (Middle East Composite) was down 143 bps, so MBF was down but at the better end of the market. According to the 9th November NAV, MBF was up 3.84% year-to-date. The yield for MBF is 4.59%.

According to our internal systems the Sukuk Income Fund (SIF) was down 49 bps in the week to 3rd November. The JP Morgan MECI Sukuk was down 71 bps and the Dow Jones Global Sukuk Index was down 50 bps, so SIF was also in line with the better end of the market. The 8th November NAV shows that SIF was up 1.54% year-to-date. The profit rate for SIF is 4.60%.

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