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Trumped

Weekly Fixed Income Comment – 22 May 2017

Overall Markets

Trumped. Last week and over the weekend The Donald provided two issues for investors to get up to speed on: the US Constitution and Middle East geopolitics. The fallout from his earlier dismissal of former FBI Director, James Comey has led to the Democrats, Trump’s enemies within the Republican Party and sections of the media to bring up the “I” word again – impeachment. His visit to Saudi Arabia has to some extent reset the US’s position in the region to pre-Obama days with Iran put back in the box, although Russian involvement in the region and the situations in Syria and Yemen, for example, have changed significantly in the last 8 years. The implications of this latter, geopolitical change will take time to develop. The implications of potential impeachment affected the markets straight away, are still with us today and will be important in the coming days.

As many of you would have read, Trump’s ability to get the tax reforms passed is now seen as very limited at best. As these, along with infrastructure spending, were key underpinnings of the “Trump trades”, last week witnessed a further reversal of these: notably weaker stock markets, lower Treasury yields and a lower US dollar. Although our read of US realpolitiks suggests that Trump will not even come close to being impeached over the latest revelations and allegations, he has undoubtedly given his opponents ammunition and the story is likely to run for a bit longer. And at a time when growth is good but not as good as a few months ago, as we have noted before. Indeed, maybe Trump’s shoot from the hip style is destined to give us this stop-start pattern to news and markets for a long time.

So, maybe not a risk-off outlook, but equally maybe not risk-on for now either. Our own analysis and that of other analysts that we follow suggests that pretty much all the Trump trade positioning has been fully unwound, and thus further moves in the direction established in the markets last week will require new positioning. The political news from Brazil last week (see below) seems to be important for Brazil but not for broader emerging markets. Furthermore, we would reiterate that a falling US dollar is good for the global economy and markets, the problems will arise if and when the greenback surges higher again. 

Bond Funds & Mandates

In The Region
MENA bonds traded within the recent range last week, as US political news caused US Treasury yields to fall but (regional) credit spreads widened. Credit spreads for UAE bonds widened by 13 bps to 134 bps as indicated by the Bloomberg USD UAE Index. The broader MECI universe did slightly better with spreads widening by 8 bps.

There was a lot of focus on Donald Trump’s first, overseas visit to Saudi Arabia as the US President, as expected, reversed Obama’s foreign policy in the Middle East and reaffirmed Saudi Arabia as a strategic partner. In return, the Kingdom announced significant investment in American infrastructure projects notably a USD 20 - 40 billion investment from its Public Investment Fund (PIF) together with Blackstone, while Saudi Aramco signed 16 agreements for a total worth of USD 50 billion. Saudi Arabia will also reinforce its military complex in order to reduce its reliance on the US, whilst a USD 100 billion plus contract between the Saudi and American Defence Ministries was signed.

It was quiet in terms of economic data, the International Monetary Fund (IMF) got most of the regional headlines as the 2017 Article IV missions to the UAE, Oman and Saudi Arabia were completed. Oman’s overall GDP growth is expected to remain flat in 2017 as non-oil growth would be fully offset by the oil production cut. The IMF was pleased by the government’s efforts to improve the business environment notably by the streamlining of regulatory processes. Additionally, Oman’s Minister of Finance announced last week its intention to issue USD 2 billion of sukuk in order to finance its budget deficit which is expected to reach 12%of GDP for 2017. UAE’s GDP growth is expected to slow down from 3% in 2016 to 1.3% in 2017 due to the oil output cuts. On the plus side, UAE’s non-oil sector is forecast to grow by 3.3% in 2017, up from 2.7% in 2016, supported by a pick-up in global trade and higher infrastructure spending ahead of Dubai Expo 2020. Additionally, the IMF is expecting fiscal adjustment to continue at a gradual pace as the introduction of VAT in 2018 should boost federal revenues.

The IMF advised Saudi Arabia not to tighten fiscal policy too fast as a self-imposed target to balance its budget by 2019 could hurt the economy severely. "A more gradual fiscal consolidation to achieve budget balance a few years later would reduce the effects on growth in the near term while still preserving fiscal buffers to help manage future risks." In line with the IMF comments, the Saudi Finance Minister declared that the 2018 fiscal budget will be “expansionary but not significantly.” In order to diversify the economy away from oil, in line with Prince Mohammed’s Vision 2023, PIF set up a defence company; the Saudi Arabian Military Industries (SAMI) will “manufacture products and provide maintenance services across units, including air and land systems, weapons and missiles, and defense electronics.” Saudi Arabia is in the world’s top five in terms of security and defence spending but with only 2% of its military equipment being produced domestically.

S&P downgraded Bank of Muscat, Oman Electricity and Oman Power by one notch following the rating downgrade of Oman’s sovereign from BBB- to BB+. Moody’s Baa1 and Fitch’s rating of BBB are notably higher and there is no sign of imminent action on these ratings. At the beginning there was a lot of activity in Oman names which were weaker by 0.50 to 1 point and wider by around 20bps in spread.

The Executive Board of the IMF completed the first review under the Precautionary and Liquidity Line (PLL) Arrangement and reaffirmed Morocco’s continued qualification for the PLL. The two-year PLL arrangement for the country, of about USD 3.4 billion was approved by the IMF in July 2016.

In the primary market, QIB issued a 5-year sukuk of USD 750 million at mid-swaps + 135 bps, the order book was USD 2.2 billion, the Middle East region took 60% of the issue, followed by Asia (25%), Europe (14%) and US (1%). Al Baraka Group (ALBRK - Bahrain) has mandated banks for a dollar perpetual sukuk which should be priced this week. Egypt’s Finance Minister announced a bond roadshow in London for a USD 1.5 to 2 billion issue.

Out of Region
The JP Morgan EMBI Global Diversified (US dollar denominated, sovereign, emerging market bonds) gained 6 bps last week, as good returns from underlying US Treasuries were offset by losses from spread related returns (i.e. spread widening). Asia was the best performer with a 49 bps gain and Middle East was the worst performer with a loss of 80 bps. Malaysia, Senegal and Cameroon performed well with an average return of 72 bps. Belize, Brazil and Lebanon were the laggards with an average loss of 144 bps. High Grade bonds performed better than High Yield. For corporates, the CEMBI Broad Diversified (US dollar denominated, corporate, emerging market bonds) recorded a gain of 4 bps also driven by Treasuries. Latin America was the worst performer with a loss of 49 bps return while Asia was the best performer with a gain of 33 bps. Diversified was the best performing sector with a 26 bps gain while Transport was the worst one with a 34 bps loss.

In the local currency markets, the JP Morgan GBI-EM Global Diversified index was down 19 bps in US dollar hedged terms last week. Currency returns were positive with the unhedged returns recording a 16 bps gain. Middle East and Africa was the best performing region with a gain of 17 bps, Latin America was the worst with a 108 bps loss. Indonesia was the best performing country with a 153 bps gain in US dollar hedged terms on the back of the S&P’s upgrade. The local currency rallied by around 25 bps. However, the upgrade will not impact Indonesia’s inclusion in any of the major emerging-market credit bond indices. Chile and Colombia also performed well with 42 bps and 25 bps gains respectively in US dollar hedged terms. The central bank in Chile surprised the market by cutting rates by 25bps to 2.5% citing the soft economic activity. In Colombia, latest data show that the economy grew at the weakest pace in the past five years and the market is expecting further easing from central bank to boost the economy. Brazil was the worst performer last week with a loss of 3.4% in US dollar hedged terms. A renewed corruption scandal involving President Temer is jeopardising the economic reform and recovery, with the prospect of an impeachment. The Brazilian real sold off by more than 8%. Argentina and Turkey also performed poorly with 95 bps and 47 bps losses respectively in US dollar hedged terms. The Argentinian economy remains fragile and vulnerable to the Brazilian scandal. In Turkey, the market has ongoing concerns about Erdogan as he regains the reins of the AK party that he founded in 2001. This gives him the authority to appoint loyalists to parliament and key posts, while removing more dissidents.

In FX markets, the Brazilian real was the only currency with a loss over last week, as the US dollar also had a tough time. The top performers were the Hungarian forint, Polish zloty and Romanian leu.

As noted above, Indonesia finally got upgraded by S&P. It was only a matter of time for this upgrade to be announced as the other two, major agencies already had it rated investment grade, and it was already priced to a certain extent. Spreads were tighter by 11 bps across the Indonesian credits and the rupiah strengthened modestly. Some quasi-sovereign credits were also upgraded, such as Pertamina Persero (PETIJ), Lembaga Pembiayaan Ekspor Indonesia (BEIAIJ) and Perusahaan Gas Negara Persero (PGASIJ).

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