Dynamic Global Economy

Weekly Fixed Income Comment – 21 August 2017

Overall Markets
A tough week coming up for the great and the good of the central banks, policymakers and academics, as they make their annual pilgrimage to the green and pleasant lands of Jackson Hole, courtesy of the Kansas City Fed. This year’s symposium, “Fostering a Dynamic Global Economy”, will take place on Thursday and Friday. As ever investors will be looking for clues about short-term policy considerations as well as what the presentations say about the longer term issues that are vexing this crowd. The cyclical, economic backdrop to this shindig is the best that the group has enjoyed for 3 years, so the mood is likely to be cautiously upbeat as economic data continue to be firm and commodity prices move sideways. Our old friend, the New York Fed Nowcast for Q3 moved above 2% for the first time last week to 2.09% and upbeat lending data from China got some attention even if some other data there was marginally below expectations. After several months out of the limelight, overstretched Chinese debt metrics have become fashionable subjects of commentary again but the authorities there seem content to direct credit through preferred channels rather than stop it altogether.

Two weeks ago it was geopolitics in the shape of North Korea, last week it was politics as President Trump lost another high profile member of staff and a small army of advisors in response to the unfortunate events in Charlottesville. Enough to keep prices of many risk assets under a bit of pressure and prices of risk free assets buoyed. Hence, 10-year US Treasury yields continue to trade within sight of 2.20% and the market continues to see limited likelihood of another Fed rate hike this year, around a 35% probability. Aside from Jackson Hole and Trump, there will also be news in the form of some meaningful US and European data.

Bond Funds & Mandates

In The Region
A fairly quiet week for MENA credit saw credit spreads tighten a little, UAE spreads tightened by 6 bps as indicated by the Bloomberg USD UAE index and by 4 bps for the broader JP Morgan MECI universe.

Saudi Arabia benefitted from a 63% year-on-year increase in oil revenue and consequently the budget deficit for H1 2017 was 72 billion riyals, increasing the probability of the full year deficit being below the targeted 198 billion. Closer to home, UAE- China trade surged to top USD 141 billion in the last 3 years, China continuing to top the list of the UAE’s major trading partners ahead of India, US, Saudi Arabia and Germany.

Moody’s affirmed Egypt rating at B3 and maintained a stable outlook. The agency noted that whilst reform progress has been impressive and political stability has improved to some degree, reform momentum may face headwinds including from the Presidential election set to take place by May 2018. There is limited visibility about the extent to which the reform program will materially improve the sovereign credit profile in the coming years. Moody's expects Egypt's credit profile to remain heavily influenced by the government's very weak, government finances for a sustained period, with already high fiscal deficits continuing to grow in nominal terms over the coming years and declining only gradually as a percentage of GDP.

A recent report by the Arab Monetary Fund and World Bank raised questions about the pension systems in the region. The report noted the need for improved data on pension related matters and the need to focus on the sustainability and affordability of the schemes. Pension benefits from the defined benefit schemes, in terms of average earnings, are amongst the highest in the world. Pension reform is rarely quick but this issue merits attention from all stakeholders.

The conflict between Qatar and its neighbours is negatively affecting Qatari banks as foreign deposits declined by 8% in July, and the banks are being encouraged to focus on efforts to raise funds from international investors and not rely on the government. Despite the ongoing dispute, Saudi Arabia made a point of welcoming Qatari pilgrims by opening the border post and offering to help with other arrangements for haj.

As the new issue chatter picks up, Bahrain remains in the news along with the Qatari banks. Jabal Omar, a Saudi real estate developer, is said to be looking to raise USD 1 billion via sukuk and Acwa Power is also looking to issue a sukuk apparently. No doubt momentum in the primary market will build in the coming few weeks with a focus on early to mid-September after Eid.

Out of Region
The JP Morgan EMBI Global Diversified (US dollar denominated, sovereign, emerging market bonds) gained 49 bps last week with the return being due to spread related factors (yield and spread tightening). In line with this, (high beta) Africa was the best performing region with a gain of 84 bps and Europe was the lowest performer with a gain of 32 bps. El Salvador, Argentina and Ghana performed well with an average gain of 231 bps, while Venezuela, Tanzania and Namibia performed poorly with an average loss of 51 bps. High yield bonds performed better than high grade. Zambian bonds were helped by the release from jail of the opposition leader following international lobbying of the government. Year to date returns for the EMBI GD are 7.88%, mainly driven by spread related factors.

For the corporate sector, the CEMBI Broad Diversified (US dollar denominated, corporate, emerging market bonds) gained 26 bps also driven by spread. Latin America was the best performer with a gain of 38 bps while the Middle East was the lowest performer with a gain of 19 bps. Transport was the best performing sector with a gain of 46 bps while Diversified and Pulp & Paper were the lowest with 13 bps gains.

In the local currency markets, the JP Morgan GBI-EM Global Diversified index was up 23 bps in US dollar hedged terms last week. Currency returns were also positive with the unhedged returns recording a gain of 50 bps. Middle East and Africa was the best performing region with a gain of 93 bps, while Asia gained just 16 bps. Argentina was the best performing country with a 140 bps gain in US dollar hedged terms. The government coalition did better than expected in the primary elections by winning in several key provinces. The results increase the probability of implementing structural reforms. South Africa and Poland also performed well with gains of 93 bps and 46 bps respectively in US dollar hedged terms. South African bonds benefited from decreasing inflationary pressure even if political risk remains high. In Poland, an improving situation in the labor market had a positive impact despite growing concerns regarding the legal issues with EU. Peru was the worst performer last week with a loss of 5 bps in US dollar hedged terms. Peruvian bonds underperformed slightly despite the deflationary trend driven by food and beverage, which represent 38% of the CPI basket. Brazil and Philippines also performed poorly with 2 bps losses each in US dollar hedged terms. The market reacted negatively to the Brazilian government’s decision to review the primary deficit targets for 2017-2020. This latest action increased the probability of further rating actions towards year-end. In the Philippines, a lack of clarity over next year’s fiscal policy and secondary market illiquidity continue to affect the bond market. Year-to-date returns for the GBI-EM are 3.80% in US dollar hedged terms and an impressive 12.94% in unhedged terms, as most EM currencies have performed well against the dollar, some very well.

In FX markets, the South Africa rand, Brazilian real and Russian ruble performed well last week. The laggards were the Philippine peso, Romanian leu and Colombian peso.

The Funds
Our internal systems show that the MENA Bond Fund (MBF) was up 25 bps last week, to the 18th August. The Bloomberg USD UAE Index was up 20 bps and the broader JP Morgan MECI (Middle East Composite) was up 26 bps, so MBF was in line with the market. According to the 17th August NAV, MBF was up 3.24% year-to-date. The yield of MBF is 4.23%.

According to our internal systems the Sukuk Income Fund (SIF) was up 32 bps over the week to 18th August. The Dow Jones Global Sukuk Index was up 3 bps and the JP Morgan MECI Sukuk was up 32 bps, so SIF was better than to in line with the market. According to the 16th August NAV, SIF was up 1.68% year-to-date. The profit rate for SIF is 4.39%.

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