(Geo) Politics VS. Growth – The Ongoing Tussles

Weekly Fixed Income Comment – 27 April 2017

Overall Markets

Ongoing concerns about geopolitics, some reduction in US and global growth rates, the French elections and the absence of inflation led to further gains for US Treasuries last week, and with credit spreads holding around recent levels it was another week when our conservative approach to duration risk cost us some performance in line with our comments last week. However, the overnight news from France has reduced some of the political risk (as markets focus on a Macron victory in 2 weeks’ time), helping risk assets and especially the European equity markets, and pushed Bund and Treasury yields higher.

As noted below, the message from the IMF last week fitted with our running commentary of recent months that despite the longer-term, structural problems, the cyclical picture for the global economy is as good as it has been for quite some time. Given that the first estimate of Q1 GDP growth for the US is due at the end of this week, and will be low on a headline basis, it is worth reiterating that the New York Fed Nowcasts are at 2.7% and 2.1% for Q1 and Q2. These levels are down from two months ago admittedly, but still respectable. Asian data continues to be strong, even if Chinese data is reminiscent of the US – firm but not as strong as it was.

Oil prices have not obviously followed this growth centric script in recent days, especially in view of the ongoing retracement of US dollar strength (associated with stronger commodity prices); retracement that has been given another push by the French results and consequent bid for the euro. Whilst we maintain that there is a bit too much focus on the level of oil inventories in the US and too little on those elsewhere around the world (which have been coming down), it must be said that overall inventories remain notably high and that we still await a balanced market (in terms of supply and demand). Speculative long positions in the futures markets are still evident and the steepening of the futures curves suggest that the spot markets are not tight, all in keeping with the fall in prices. This is not to say that the markets are not moving towards a better balance, a move that should be supported by ongoing production agreements between OPEC and NOPEC at the end of May.

Bond Funds & Mandates

In The Region
MENA debt traded in a range last week despite a 7% drop in oil prices. Credit spreads for UAE bonds widened by 3 bps to 145 bps as per the Bloomberg USD UAE OAS Index. The broader MECI universe was similar with spreads also widening by 3 bps. The primary was quiet last week.

2017 GDP growth forecasts created a lot of regional headlines. The International Monetary Fund (IMF) in its latest, World Economic Outlook update raised its 2017 global growth forecast from 3.4% in January to 3.5%, mentioning that the global economy is gaining momentum. However, it lowered its forecasts for Middle East oil-exporting countries from 2.9% in October 2016 to 1.9%, noting that “the subdued pace of expansion reflects lower headline growth in the region's oil exporters, driven by the November 2016 OPEC agreement to cut oil production." Kuwait’s economy is now expected to contract by 0.2% in 2017 down from a forecast for a 2.6% expansion in October 2016. UAE's economy is now projected to grow at 1.5% in 2017 down from 2.5% in January 2017. Saudi Arabia’s 2017 GDP growth outlook was unchanged at 0.4% but the 2018 forecast was cut from 2.3% to 1.3% on the back of “lower oil production and ongoing fiscal consolidation.” On a positive note, Qatar’s 2017, growth forecast has been revised up from 2.7% to 3.4%.

Fiscal consolidation seems to have reached a halt in Saudi Arabia for now. King Salman declared that bonuses for Saudi state employees were restored as spending cuts over the past two years “have resulted in better than forecasted revenues and reduction in expenditures for the government budget.” Indeed, the Q1 2017 fiscal deficit was down to SAR 26 billion versus an expectation of SAR 54 billion. The increase of public sector workers’ incomes should boost domestic consumption and revive low GDP growth expectations for 2017. In order to bolster the economy further, the Finance Minister is studying the possibility to offer “almost interest-free” loans to companies in labour-intensive industries.

Earning season is in full swing. In the Banking sector, Emirates NBD and Sharjah Islamic Bank Q1 2017 net profits were up by 4% and 5.9% respectively, while Emirates Islamic Bank net profit jumped from AED 45 million in Q1 2016 to AED 221 million led by a 49% improvement in impairments allowances. The combined FGB and NBAD group net profit increased by 12.4% on the back of “a healthy operating performance driven by higher business volumes and investment gains, coupled with disciplined risk management and the realisation of cost synergies in relation to the merger between the two banks.” On the negative side, Commercial Bank of Dubai and RAK Bank Q1 2017 net profits dropped by 33.5% and 38% respectively on the back of higher impairment losses. Outside of the UAE, results were mixed as QIB and NBK net profits rose by 12.8% and 8.1% respectively but Commercial Bank of Qatar net profit fell by 67%. In the Real Estate sector, Dar Al Arkan Q4 net profit dropped by 79% as the company was negatively impacted by lower property sale revenues while “the decrease in finance cost positively impacted and contributed to the net income.”

Moody's affirmed Abu Dhabi Islamic Bank's A2 credit rating while maintaining a negative outlook. The credit rating agency is still expecting a strong support from the UAE’s government in case of difficulties. There is talk of Dubai Government issuing sukuk, with Oman still being talked about as an issuer too. Saudi Arabia is likely to tap domestic and international bond markets again in 2017, as the government declared its preference for borrowing versus drawing down reserves.

Out of Region
The JP Morgan EMBI Global Diversified (US dollar denominated, sovereign, emerging market bonds) gained 31 bps last week. The underlying return from spread was the main contributor. On a regional basis, Africa was the best performer while Middle East was the worst performer. Looking at countries, Argentina, Mozambique and South Africa performed well with an average return of 3.33% but Venezuela, Bolivia and Tanzania were the laggards with average loss of 0.73%. High grade bonds performed better than high yield. For the corporate sector, the CEMBI Broad Diversified (US dollar denominated, corporate, emerging market bonds) gained 27 bps also driven by spread. Europe and Latin America were the best regions with a 51 bps return each, while Asia was the worst performer with a 4 bps gain. Turkish bonds and sukuk performed quite well following the referendum, albeit in low volumes.

In the local currency markets, the JP Morgan GBI-EM Global Diversified index was up 35 bps in US dollar hedged terms last week. Currency returns were flat with the unhedged returns recording a similar 38 bps gain. Middle East and Africa was the best performing region with 102 bps gain, while Asia was the worst performing region with a gain of 2 bps. Colombia was the best performing country with a 115 bps gain in US dollar hedged terms as the latest data points to an improvement in the trade balance driven by an increase in export revenue and improving inflation expectations (towards 4% at the end of the year) are providing more room for manoeuvre to the central bank. Turkey and South Africa also performed well with 111 bps and 102 bps gains respectively in US dollar hedged terms. Local political issues have hindered both countries lately. However, as the dust settles, the nervy markets are focusing more on fundamentals in both countries. The new government in South Africa is continuing to provide more reassurance to the market, while the AKP victory in Turkey at the referendum is yet to be followed by a clear agenda, although Erdogan could be able to strengthen his position and extend his term in office to 2029. Mexico was the worst performer with a loss of 18 bps in US dollar hedged terms. Rising inflationary pressure combined with the uncertainty of US trade policy continue to affect the Mexican bond market, even though the Mexican government remains positive regarding the renegotiations of the NAFTA rules and the resilience of its economy. Indonesia also performed poorly with a 9 bps loss in US dollar hedged terms as local politics negatively affected the market.

In the FX markets, the South African rand, Turkish lira and Hungarian forint performed well last week. The laggards for the period were the Mexican peso, Philippine peso and Chilean peso.

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