A Small Breather

Weekly Fixed Income Comment – 14 August 2017

Overall Markets
North Korea was obviously the key global issue last week as the rhetoric from all sides continued against a backdrop of risk assets that have continued to perform over the summer. There was a sense in the middle of the week that investors were keen to reduce risk somewhat ahead of the weekend, producing a weak finish to the week for equity and credit markets. Although there were no shocks over the weekend, this tricky issue seems destined to remain in focus for some time and will likely subdue risky assets during the rest of August.

Economic news of any importance has been limited, the global and regional economies seem to be growing at steady paces in line with recent data and expectations. The combination of the geopolitical news and stable economics has helped the risk free assets to rally with 10-year US Treasury yields down to 2.22% from the their July high just under 2.40%, helped by the notable rally of Bunds with the 10-year yield down to 0.42% from just over 0.60% in July with the ECB fears a seemingly distant memory. At the margin, data released earlier today in China were soft and this week will see the release of the early indicators in the monthly cycle of US data: Empire State manufacturing, NAHB and Philadelphia Fed. manufacturing surveys.

Bond Funds & Mandates

In The Region
In a less positive week for credit markets, UAE bonds and sukuk held up well last week with the Bloomberg UAE USD Index up 10 bps and credit spreads widening by 6 bps to 136 bps. The broader MENA market had a tougher week with the JP Morgan MECI down 17 bps with spreads wider by 11 bps to 244 bps.

Amidst some concerns about the tight timetable for the GCC to implement VAT, the parliament in Kuwait muddied the waters further when they rejected the introduction of VAT in 2018 as agreed by the cabinet. The main concerns being the ability to efficiently implement the tax and control the impact on the less wealthy parts of the population. Staying with Kuwait, inflation in June was 1.4% yoy, following the revamp of the CPI basket with housing now at 33% from 29%. Housing inflation helped the overall inflation rate to drop and the inflation average for 2017 is likely to be below 2% compared to 3.5% in 2016.

Elsewhere, the implementation of VAT is progressing fairly well as Saudi announced the deadline for business to register, after the UAE provided more details earlier. Saudi Arabia’s Purchasing Managers’ Index (PMI) rose from 54.3 in June to 55.7 in July, in line with improvements since April. The latest data represent the biggest improvements for 3 months. In other news, Saudi Arabia will allow foreign companies to own engineering services companies in full, without requiring them to partner with a Saudi-owned firm, if they operate in at least four countries and have existed for at least 10 years. In its earnings call, Dar Al Arkan said that although land prices remain soft it may use its large cash balance to buy back or tender for its 2018 sukuk, this would be in line with its practices for earlier sukuk.

Remittances from Oman reached its historical peak according to the central bank’s data. Remittances increased by almost 30% between 2012 and 2016. Increased numbers of blue-collar workers being the main reason for the surge, the expat workforce in 2016 was 2.8 times the 660,950 number recorded in 2007.

Egypt recorded a sharp increase in inflation during the month of July as subsidy cuts and rises in energy prices came into effect. Annual inflation reached 33% in July from 29.8% recorded in June. From here inflation is expected to fall to around 24% by year-end as the effects of the initial subsidy cuts and free floating currency fade, before going back to single figures next year. Thereafter, commitment to the IMF economic program should anchor price stability.

As the conflict between Qatar and its neighbours continues, Moody's changed the outlook on Qatar's banking system to negative from stable due to the weakening operating conditions and the potential weakening of the government’s ability to support the financial sector. According to the rating agency, the gradual economic slowdown, combined with Qatar's ongoing dispute with some neighbouring countries and continued challenges in the construction and contracting sector, will lead asset quality to dip slightly. Moody’s expects Qatari GDP growth to slow substantially to 2.4% in 2017, credit growth dipping below 7% for 2017 and 2018 and a double-digit budget deficit is expected for 2017.

The primary market continues to prepare for the end of the summer lull. Bahrain has mandated five international and regional banks for an upcoming USD bond issue. The size of the issue has not been set but is expected to be of benchmark size. The Qatari banks continue to work on funding strategy in the crisis environment.

Out of Region
The JP Morgan EMBI Global Diversified (US dollar denominated, sovereign, emerging market bonds) lost 20 bps last week. There was a notable difference between the contributions of the two overall, performance drivers; returns from the underlying US Treasury market were plus 55 bps, spread related returns were minus 74 bps as credit spreads widened 12 bps for the index in the risk-off environment. Africa, often the high beta region, was the worst performing region with a loss of 67 bps and Asia was the best performer with a loss of 4 bps. Tunisia, Kenya (despite the elections) and Argentina performed well with an average gain of 105 bps, while Venezuela, Gabon and Zambia performed poorly with an average loss of 205 bps. High grade bonds performed better than high yield.

For the corporate sector, the CEMBI Broad Diversified (US dollar denominated, corporate, emerging market bonds) lost 4 bps, Treasury related returns were plus 40 bps and spread related were minus 44 bps. Asia was the best performer with a gain of 11 bps while the Middle East was the worst performer with a loss of 20 bps. Diversified was the best performing sector with a gain of 19 bps, Metals and Mining was the worst one with a 32 bps loss.

In local currency markets, the JP Morgan GBI-EM Global Diversified index was down 5 bps in US dollar hedged terms last week. Currency returns were negative with the unhedged returns recording a 22 bps loss. Middle East and Africa was the best performing region with a gain of 12 bps, while Europe was the worst one with a loss of 17 bps. Colombia was the best performing country with a 69 bps gain in US dollar hedged terms. Inflation declined further in July to reach 3.4% from 5.75% at the end of last year driven by regulated prices. Czech Republic and Indonesia also performed well with gains of 32 bps and 22 bps respectively in US dollar hedged terms. The Czech bond market rallied after the first rate increase by the central bank since 2008. Inflation unexpectedly accelerated in July. In Indonesia, stable inflation and optimism about future VAT receipts continue to support the bond market. Argentina was the worst performer last week with a loss of 52 bps in US dollar hedged terms. The political cycle, which kicked off last weekend with the primary elections, increases concerns about the country’s future path. Brazil and Turkey also performed poorly with 54 bps and 52 bps losses respectively in US dollar hedged terms. The Brazilian government could raise the fiscal target for this year and next, while prospects for further pension reforms remain downbeat. In Turkey, while election risks have diminished, the stickiness of inflation expectations remains a concern for the central bank.

In FX markets, the Chilean peso, Hungarian forint and Colombian peso performed well last week. The laggards were the Brazilian real, Philippine peso and Polish peso.

The Funds
Our internal systems show that the MENA Bond Fund (MBF) was down by 15 bps last week. As noted above, the Bloomberg UAE index was up by 10 bps and the JP Morgan MECI was down by 17 bps, so the fund was at the lower end of this range. According to the 10th August NAV, MBF was up 3.12% year-to-date. The yield for MBF is 4.18%.

The Sukuk Income Fund (SIF) was down by 5 bps last week according to our internal systems. The Dow Jones Sukuk Index was up by 15 bps whilst the JP Morgan MECI Sukuk index was down by 1 bps, so SIF was a little below the market. The 9th August NAV shows that SIF was up 1.48% year-to-date. The profit rate for SIF is 4.39%.

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