Weekly Fixed Income Comment – 15 May 2017
Right about oil prices, not so right about post-Macron markets. Last week, we noted the financial futures positions were no longer an obvious overhang for oil prices and judging by last week’s rebound this seems to be a valid observation. Inventory levels of crude and downstream products are still high and need to be watched but a number of analysts forecast notable drawdowns in the coming weeks and months. These will need to be watched along with the OPEC/ NOPEC discussions. Our sense that there would be an additional boost for risk assets following the Macron victory was not so accurate, although we did hedge our comments about this. It turns out that Macron was completely in the price (of markets) already, with risk assets trading sideways with low volatility last week.
All in all it seems as if markets, economic data and political news are all fairly aligned and in equilibrium for now. We need new news to create the next moves of note. In the meantime the not too hot, not too cold world persists – enough growth to support risk assets, not enough to push up inflation and (policy) interest rates, as evidenced by the moderate US inflation data last week. There will be a couple of notable, regular survey results released in the US and Europe this week. If the economic data released today in China and the US is a guide, this will continue to support the idea that growth has plateaued at slightly lower levels than a few months ago.
Bond Funds & Mandates
In The Region
MENA bonds and sukuk traded well last week supported by rebounding oil prices, minimal new supply and lower US Treasury yields. Credit spreads for UAE bonds tightened by 8 bps to 121 bps as indicated by the Bloomberg USD UAE Index. The broader MECI universe did slightly less with spreads tightening by 2 bps. In the primary market Oman Electricity priced its 10-year deal at mid-swaps + 285 bps, supported by strong international demand.
The UAE economy is maintaining a healthy pace of growth with the Dubai Economy Tracker up from 56.6 in March to 57.7 in April. Dubai’s economy experienced its strongest non-oil, private sector growth since February 2015 led by a significant increase in output and new orders, while selling prices remained under pressure. The employment rate improved slightly but is still subdued. Having lagged the other key sectors since the beginning of the year, the construction sector index surprised on the upside as it was the fastest growing index last month, expanding from 54.8 in March to 57.9 in April as infrastructure investments accelerated sharply ahead of Expo 2020. The wholesale and retail sector index recorded a 2 year peak of 57.8 in April; employment rose for the first time since the beginning of 2017 as retailers are forecasting improvements in demand but input prices rose keeping revenues under pressure. The tourism and travel index improved slightly from 55.3 in March to 57.0 in April; firms were able to increase selling prices and improve margins.
In Saudi Arabia, transparency is improving as the Ministry of Finance released its first ever, quarterly, fiscal disclosure. The deficit fell by 71% in Q1 2017 vs. Q1 2016 to USD 6.93 billion as government revenues increased by 72%, mainly on the back of a 115% increase in oil revenues as oil prices averaged USD 35.34 in Q1 2016 vs. USD 54.75 in Q1 2017. Fiscal consolidation was evidenced as total spending was down by 2.5% in Q1 2017. Saudi Arabia reduced civil servant salaries by 5.2% in Q1 2017 but some of the fiscal savings have been reversed as the government decided to reinstate bonuses in April 2017. Infrastructure spending is expected to pick up as Mohamed bin Salman revealed plans to construct a major entertainment complex including cultural and sporting activities. This project falls within the Vision 2030 transformation plan.
S&P downgraded Oman’s credit rating from BBB- to BB+ and revised its outlook to negative, citing heightened external financing needs due to lower oil prices. According to the rating agency, “the negative outlook reflects the potential for Oman’s income level to weaken and for its fiscal and external positions to deteriorate.” Oman’s external position fell from 60% of current account receipts in 2016 to 30% in 2017. S&P is expecting GDP growth to slow down to an average of 2% between 2017 and 2020. With the other agencies still rating Oman as investment grade, this downgrade had minimal impact on Omani bonds.
Out of Region
The JP Morgan EMBI Global Diversified (US dollar denominated, sovereign, emerging market bonds) gained 37 bps last week. Returns from both spreads and underlying US Treasuries contributed. On a regional basis, while all regions performed well, Africa was the best performer with a 72 bps gain due to the ongoing, strong bid for African credits. Fitch revised Ghana’s outlook on the B rating to stable from negative. Asia was the worst performer with a gain of 13 bps. Looking at countries, Venezuela, Mozambique and Ethiopia performed well with an average return of 2.93%, Tunisia, Tanzania and Trinidad & Tobago were the laggards with an average loss of 46 bps. Markets reacted positively to the news that Mozambique completed its foreign debt audit after three delays. High yield bonds performed better than high grade. Turkish credits traded heavily last week with spreads widening a little more than the overall market.
For the corporate sector, the CEMBI Broad Diversified (US dollar denominated, corporate, emerging market bonds) recorded a gain of 21 bps driven by US Treasuries. Latin America was the best performer with a 40 bps return while Asia was the worst performer with a loss of 1 bps. Oil and Gas was the best performing sector with a 49 bps gain while Industrial was the worst one with an 84 bps loss.
In local currency markets, the JP Morgan GBI-EM Global Diversified index was up 6 bps in US dollar hedged terms last week. Currency returns were also positive with the unhedged return a 55 bps gain. Europe was the best performing region with a 31 bps gain, while Asia was the worst performing region with a loss of 22 bps. Hungary was the best performing country with a 65 bps gain in US dollar hedged terms. Markets reacted positively to the Fitch review of Hungary. In recent years, the government’s sound management resulted in lower government deficits and strong current account surpluses. Romania and Brazil also performed well with 62 bps and 60 bps gains respectively in US dollar hedged terms. Romania will be the fastest growing country in 2017 according to EU forecasts, although it will be the only one breaching the 3% deficit ceiling. In Brazil, inflation continues to surprise on the downside. In April, the IPCA annual inflation rate was 4.08%, below the 4.5% midpoint of BCB’s (central bank) target range for the first time since 2010. Argentina was the worst performer last week with a loss of 2% in US dollar hedged terms. Inflation surprised to the upside again, prompting analysts to revise up 2017 annual inflation forecasts to 21.2% from 20.8%. The government is also planning to force foreign companies to source more goods locally. Indonesia and Chile also performed poorly with 57 bps and 56 bps losses respectively in US dollar hedged terms. The latest data in Indonesia showed that the current account deficit widened to 1% of GDP, mainly due to a deficit in oil and gas trade balances. In Chile, market sentiment remains negative due to changes in prices and demand for copper. However, solid economic fundamental should help absorb shocks in the medium term.
In FX markets, the Brazilian real, Russian ruble and Colombian peso performed well last week. The laggards were the Polish zloty, Turkish lira and Romanian leu.
Our internal systems show that the MENA Bond Fund (MBF) was up by 0.14% last week to May 12th. The Bloomberg UAE Index was up by 0.16%, the JP Morgan MECI and the JP Morgan MECI GCC indices were up by 0.33% and 0.27% respectively, so MBF’s performance was slightly behind the market. According to the 11th May NAV, MBF was up 2.93% year to date. The yield on MBF is 4.23%, duration is 3.33, volatility is 1.74%.
The Sukuk Income Fund (SIF) was up by 0.10% last week to Friday 12th May, according to our internal systems. Indices were positive as the JP Morgan MECI Sukuk Index and the Dow Jones Sukuk Index were up by 0.23% and 0.10% respectively. According to the 10th May NAV, SIF was up by 1.80% year to date. The profit rate for SIF is 4.10%, duration is 3.47, volatility is 1.83%.
Watching for new news,
The FI Team
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