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Quieter Markets

Weekly Fixed Income Comment – 29 May 2017

Overall Markets
Last week was one of the quieter ones of recent times. Equity markets generally continued to make gains, as they had at the end of the previous week after the latest Trump related news and Brazilian developments had knocked them down. So at the moment, buy the dips seems to be the mentality. The same applied to credit spreads as they tightened last week in keeping with the rallies in equity markets. Meanwhile, some more slightly softer economic data in the US kept US Treasury yields in a tight range, with the anticipated Fed rate hike getting closer (June 14th), and the US dollar also traded sideways.

The extension of the oil production agreement until March 2018 ended up disappointing the market judging by the fall in prices on Thursday, continuing the pattern of sharp moves, up and down, that have characterized the last three months. Viewed from a 12 month perspective, the range for WTI of mid-40s to mid-50s is continuing.

It may be a holiday shortened week this week but there will still be some noteworthy data to watch: the US payroll numbers on Friday and PMI survey data in China on Thursday and Friday, at a time when there is a lot of focus on the (slower) pace of growth there. New issues in the MENA region will obviously less important for a few weeks now that we are in Ramadan. The political debate in the US will obviously continue to make headlines.

Bond Funds & Mandates

In The Region
MENA bonds and sukuk traded in a range again last week, in a good week for risk assets generally (e.g. equities and credit spreads). There was some support from oil prices despite the volatility caused by OPEC/NOPEC only delivering limited, further production cuts. Credit spreads for UAE bonds tightened by 3 bps to 131 bps as indicated by the Bloomberg USD UAE OAS Index. The broader MECI universe did better with spreads tightening by 7 bps. The primary market was fairly busy in the last week before Ramadan and the approaching summer season. National Bank of Kuwait priced its USD 750 million 5-year bond at mid-swaps + 100 bps and Al Baraka issued a USD 400 million Tier 1, 5-year bond at a YTM of 7.875%. Oman priced USD 2 billion of a 7-year sukuk at mid-swaps + 235bps, and Egypt issued a USD 3 billion by way of re-tapping its 2022, 2027 and 2047 issues.

All eyes were on the OPEC meeting and it was light in terms of GCC macroeconomic data last week aside from some money supply and inflation figures. Banking sector liquidity conditions are easing further as UAE’s loan-to-deposits decreased slightly from 99.7% in March to 99.4% in April. Credit growth was steady at 5.3% in April while deposit growth accelerated strongly being up by 7.3% on the back of higher resident deposits. Inflationary pressures are edging down in the UAE while being stable in Kuwait and Bahrain. UAE’s monthly inflation rate recorded its first negative print for 2017 at -0.38% in April with the annual rate down from 2.96% in March to 2.17% in April. In Bahrain, the cost of living increased slightly from 0.8% in March to 0.9% in April while being flat at 2.63% in Kuwait.

The GCC-wide Value Added Tax (VAT) agreements have come into force following its ratification by the UAE last week. Saudi Arabia was the first country to endorse the agreement earlier in 2017. The introduction of VAT in the UAE should generate revenue of AED 12 billion and AED 20 billion in 2018 and 2019 respectively. Additionally, Saudi Arabia announced the implementation of selective taxes from June 10th 2017. Selective taxes will be implemented across GCC countries and will target several items including tobacco and power drinks that will be taxed at a 100% rate while soda will be taxed at a 50% rate. Saudi Arabia should generate extra revenue of SAR 7 billion for the last 6 months of 2017. The GCC tax plans are in line with IMF’s recommendations to diversify revenues away from oil. The IMF is expecting the implementation of the 5 % VAT within the GCC countries to boost GDP growth by an additional 1.5%.

Moody’s revised its outlook from negative to stable for the UAE and Kuwait. Key drivers of the outlook change were “ the effective policy response to the low oil price environment via an acceleration in the country's reform agenda; the expected improvement in the fiscal and current account positions; and the economy's growth and diversification prospects.” According to Moody’s, “ there are sufficient signs of the {Kuwaiti} government's institutional capacity to effectively implement its fiscal and economic reform program to preserve creditworthiness in the medium-term, which has the stated objective of diversifying and enhancing the economic base and its budgetary revenues.” The rating agency also downgraded the credit rating of Qatar from Aa2 to Aa3 mentioning Qatar's external position and uncertainty over the sustainability of the country's growth model beyond the next few years; Moody’s move was counterbalanced by the revised outlook from negative to stable. The moves did not have any market impact, indeed longer dated Qatari bonds gained more than 1 point during the week

Ezdan Holdings (ERESQD) announced its plan to go private, this had negative impacts on both the equity and sukuk prices, with the 2021 and 2022 issues losing 2 to 3 points over the week. There appears to be no material change in the company’s credit quality, hence this move appears exaggerated.

Out of Region
The JP Morgan EMBI Global Diversified (US dollar denominated, sovereign, emerging market bonds) gained 52 bps last week. The return was due to spread related returns with good sentiment but limited flows. Middle East was the best region with a 90 bps gain and Asia was the worst performer with a gain of 16 bps. Iraq, Venezuela and Ghana performed well with an average return of 252 bps. Belize, Tunisia and Tanzania were the laggards with an average loss of 155 bps. High yield bonds performed better than high grade ones, in keeping with spreads being key. For the corporate sector, the CEMBI Broad Diversified (US dollar denominated, corporate, emerging market bonds) recorded a gain of 22 bps, also driven by spread. Africa was the best region with a gain of 52 bps return while Asia was the worst performer with a gain of 8 bps. Oil and Gas was the best performing sector with 34 bps gain while Consumer was the worst with 4 bps loss.

In local currency markets, the JP Morgan GBI-EM Global Diversified index was up 34 bps in US dollar hedged terms last week. Currency returns were also positive with the unhedged returns recording a 115 bps gain. Middle East and Africa was the best performing region with a gain of 99 bps, while Asia was the worst one with a gain of 3 bps. Brazil was the best performing country with 157 bps gain in US dollar hedged terms. The political saga in the country continues with President Temer still resolute about remaining in power. However, the head of the BNDES, seen as Temer’s key ally, resigned. The market remains relatively calm because economic policy should not change under an impeachment scenario. Fiscal austerity will still be required given the deterioration of public finances. Moody’s cut Brazil’s credit outlook based on political uncertainty. South Africa and Turkey also performed well with 99 bps and 80 bps gains respectively in US dollar hedged terms. In South Africa, the market reacted positively because of inflation dropping to 5.3% in April from 6.1%. Nevertheless, concerns remain with upcoming events such as a vote of no confidence in parliament, and the five-yearly ANC policy conference next month. In Turkey, the market is slowly coming to terms with Erdogan back at the helm of the AKP while inflation keeps drifting higher. On the laggard side, Chile was the worst performer last week with a loss of 70 bps in US dollar hedged terms. The disappointing growth outlook continues to weigh on investors. Russia and Mexico also performed poorly with 50 bps and 28 bps losses respectively in US dollar hedged terms. While economic reforms continue to positive impact in Russia, the geopolitical situation has yet to improve. In Mexico, inflation remains a concern with the market expecting more hikes from the central bank. Banxico hiked 25 bps to 6.75% on inflation concerns at their last meeting, and analysts forecast an additional 25 bps hike in June.

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

The Funds
Our internal systems show that the MENA Bond Fund (MBF) was up by 0.17% last week to May 26th. The Bloomberg UAE Index was up 0.21% whilst the JP Morgan MECI and the JP Morgan MECI GCC indices were up by 0.36% and 0.33% respectively, so MBF’s performance was fractionally behind the market. According to the 25th May NAV, MBF was up 3.13% year to date. The yield on MBF is 4.31%, duration is 3.35, volatility is 1.84%.

The Sukuk Income Fund (SIF) was up by 0.08% last week to Friday 26th May. Indices were up too, the JP Morgan MECI Sukuk Index and the Dow Jones Sukuk Index were up by 0.22% and 0.10% respectively. According to the 24th May NAV, SIF was up by 1.94% year to date. The profit rate for SIF is 4.14%, duration is 3.47, volatility is 1.88%.

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