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Steady As She Goes

Weekly Fixed Income Comment – 17 July 2017

Overall Markets
It was a better week for GCC, MENA and emerging market bonds/ sukuk last week following the weaker performance in June and early July that we wrote about last week. Yields, spread tightening and a firmer, underlying US Treasury market all contributed. We have also written about inflation recently, particularly in the US and developed country contexts, and once again this theme was prevalent. Whilst our own take on Janet Yellen’s (Chair of the US Federal Reserve or Fed) testimony was that it largely repeated recent statements and minutes from the Fed, others noted a more uncertain tone on inflation and when it would pick up. This latter view impacted the market, with the probability of another rate hike this year going below 50%. Thus, in contrast to the trend move to a flatter yield curve in the US that we have seen for much of this year, since mid-June the curve has steepened with 2-year yields up 3 bps but 10-year yields up nearly 20 bps. In other words, the repricing of the Fed has been key. This has further undermined the US dollar and helped emerging market bonds. The debate about inflation is not dying down and remains a focal point for the markets. There is a limited amount of important economic data out this week, so the positive tone in the markets could well continue buoyed by the twin pillars of reasonable growth and low inflation.

Oil prices also had a stronger week following a similarly testing June. Somewhat better US inventory data and hopes that upcoming OPEC/NOPEC discussions might be positive helped this uptick in prices. So keep an eye on the newswires over the coming week or so.

Bond Funds & Mandates

In The Region
MENA credits traded well last week supported by firmer oil prices, minimal new supply and lower US Treasury yields. Credit spreads for UAE bonds widened by 1 bp to 134 bps as indicated by the Bloomberg USD UAE Index. The broader MECI universe did slightly better with spreads tightening by 3 bps.

The UAE economy maintains a reasonable pace of growth with the Dubai Economy Tracker up from 55.0 in May to 56.5 in June, led by a significant increase in output and new orders, although selling prices remained under pressure. The employment rate remains unchanged and is still subdued. The wholesale & retail trade sector index surprised on the upside as it was the fastest growing index last month, up from 55.5 to 58.0 in June boosted by Ramadan and Eid related spending. The construction index improved from 56.2 to 57.4, firms were able to increase selling prices and improve margins. The travel and tourism sector index rose as selling prices were cut by the most since October 2016, in order to attract tourists during the low season. Additionally, Dubai’s non-oil foreign trade rose by 2.7% in Q1 2017. “Dubai has been able to offset the impact of key challenges including major currency fluctuations and slower global economic growth, and increase its non-oil foreign trade as well as cement its position as a regional and global business hub,” according to Sheikh Hamdan.

Fitch affirmed the ratings of several UAE banks. Abu Dhabi Islamic Bank, Al Hilal and Emirates Islamic Bank kept their A+ rating. Dubai Islamic Bank and Mashreq Bank maintained their A rating. A- ratings for Commercial Bank of Dubai and Noor Bank were affirmed. Similarly for the BBB+ ratings of Bank of Sharjah, National Bank of Ras Al-Khaimah and Sharjah Islamic Bank.

Q2 2017 earnings season started. In line with analyst’s expectations, results are mixed in the banking sector. On the plus side, net profits for National Bank of Kuwait, QNB and Mashreq were up by 10.7%, 3.4% and 3.6%. Sharjah Islamic Bank’s H1 2017 net profit rose by 6.2%. On the minus side, Commercial Bank of Dubai’s H1 2017 net profit fell by 31.6% on the back of higher provisions, although generally the provisioning picture has improved.

The IMF approved the second, USD 1.25 billion, loan tranche for Egypt under their facility and noted the good progress that the country has made with reforms.

Elsewhere in the UAE, Emirates airline was said to be scaling back employees and streamlining operations. There have been rumours about possibility of combining operations with its low-cost sister Fly Dubai and today they signed a partnership agreement with respect to some aspects of their businesses.

Out of Region
The JP Morgan EMBI Global Diversified (US dollar denominated, sovereign, emerging market bonds) gained 106 bps (or 1.06%) last week. Credit spread related returns were the main contributors although returns from underlying US Treasuries were also positive. Africa was the best performing region with a gain of 159 bps and Asia was the worst performer with a gain of 46 bps. Pakistan, Tanzania and Bulgaria performed poorly with an average loss of 20 bps, while Ecuador, Cote d’Ivoire and El Salvador performed well with an average gain of 226 bps. The Indonesian government issued a 7-year bond at mid swaps + 158 bps which was well received and closed almost 20 bps tighter, the curve closed the week 5 bps tighter having previously widened given the expectation of this supply. High Yield bonds performed better than Investment Grade ones. For corporates, the CEMBI Broad Diversified (US dollar denominated, corporate, emerging market bonds) also gained 50 bps, although here the main driver was US Treasury returns. Similarly, Asia was the worst performer with a gain of 33 bps while Europe was the best performer with a gain of 72 bps. Oil and Gas was the best performing sector with an 81 bps gain while Diversified was the worst with a 27 bps gain.

In local currency markets, the JP Morgan GBI-EM Global Diversified index was up 66 bps in US dollar hedged terms last week. Currency returns were also positive with the unhedged returns recording a 255 bps gain. Middle East and Africa was the best performing region with a gain of 166 bps, while Asia was the worst one with a gain of 56 bps. South Africa was the best performing country with a 166 bps gain in US dollar hedged terms. Strong mining output provided some positive news for the country. However, there are growing concerns about the mandate of the central bank. Czech Republic and Peru also performed well with gains of 100 bps and 88 bps respectively in US dollar hedged terms. The Czech bond market benefited from reduced inflationary pressures with investors expecting action from the Central Bank. Inflation is also expected to remain on a declining path in Peru. Chile was the worst performer last week with a loss of 34 bps in US dollar hedged terms. The downgrade by S&P of the country rating by one notch to A+ negatively affect the bond market. Growing local, social issues are the main reason of the downgrade. Malaysia and Philippines also performed poorly with 4 bps and 1 bps losses respectively in US dollar hedged terms. The Malaysian economy remains vulnerable despite the latest data showing 5.6% growth for Q1. Hence, the Central Bank is expected to keep its cautious stance. In Philippines, weak private consumption affected negatively the latest growth data. Further, analysts have lowered their inflation forecast this year amid a sustained downtrend in domestic consumer prices.

In the FX markets, the Brazilian real, the Mexican peso and South African rand performed well last week. The laggards were the Philippine peso, Peruvian sol and Malaysian ringgit.

The Funds
Our internal systems show that the MENA Bond Fund (MBF) was up by 0.54% last week to July 14th. The Bloomberg UAE Index was up by 0.29% whilst the JP Morgan MECI and the JP Morgan MECI GCC indices were up by 0.79% and 0.84% respectively, so MBF’s performance was in line with the market. According to the 13th July NAV, MBF was up 2.54% year to date. The yield on MBF is 4.55%.

The Sukuk Income Fund (SIF) was up by 0.12% last week to Friday 14th July according to our internal systems.Indices were up too, the JP Morgan MECI Sukuk Index and the Dow Jones Sukuk Index were up by 0.56% and 0.25% respectively.The profit rate for SIF is 4.46%.

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