A Pause For Reflection ?

Weekly Fixed Income Comment – 30 October 2017

Overall Markets

Although oil prices have not been a driver of broad market trends recently, they have been noteworthy nonetheless. Hence a short note on them here; apologies for a lot of numbers.

Using IEA data: total demand will be 97.7 mbd in 2017, up 1.7% from 2016’s 96.1 mbd, with Q3 and Q4 2017 demand at 97.9 and 98.5 mbd respectively; total supply for Q3 2017 is seen at 97.8 mbd, up from 97.0 mbd for 2016. To make the maths clear, oversupply in 2016 was 97.0 – 96.1 = 0.9 mbd, and excess demand was 97.9 – 97.8 = 0.1 mbd in Q3 with the excess moving higher. JP Morgan’s Q3 numbers are 98.8 (demand) and 97.9 (supply) for excess demand of 0.9 mbd, moving up to 1.2 mbd in Q4, following excess demand of 1.9 mbd in Q2. Goldman Sachs see Q3 as being the period of most excess demand. A lot of numbers and quarters but hopefully the broad picture is clear: oversupply in 2016 has been replaced by excess demand in 2017. By way of comparison, oversupply was around 2 mbd at the end of 2014 and through 2015.

In large part oil demand has increased as a result of the strong economic growth seen this year, and growth still looks solid. The more limited increase in supply has been due to good compliance to the OPEC-NOPEC production agreements (with Saudi Arabia notably doing their bit and signs that the agreement will remain in place next year), and lower production increases in the US than expected with rig counts falling again recently (raising renewed questions about the efficiency gains and costs of shale wells) although hurricane effects need to be factored in.

The balance of demand and supply can be seen in the stock or inventory numbers. Earlier concerns about the high level of inventories of both crude and refined products, have given way to comments about the unprecedented speed with which some stocks have fallen. Crude stocks have been above their 5 year range for an extended period of time but have recently move back into it, refined product inventories are firmly in the range now, floating storage have fallen to the bottom of the 5 year range and below their 5 year average.

The combination of these factors has led to backwardation in both the Brent and WTI curves, whereby prices for spot (and near term futures) are higher than for longer date futures indicating genuine tightness in the current market. In so far as this makes it less economic for producers, particularly US shale producers, to hedge future production then there is less commitment to increase production in the short to medium term. Lastly, our take on the financial futures market that can often influence short term movements in prices, is that positions are not that extreme at the moment and hence not an obvious source of pressure, upwards or downwards.

The demand-supply balance may be about as good as it gets for now and inventories remain high even if they are lower, so whilst a sharp reversal of the recent oil price gains may not be on the cards, neither should we expect prices to climb much higher for much longer. As ever, forecasts about whether oversupply or excess demand awaits us in 2018 vary.

Elsewhere it will be a busy second half of the week in the US where much data and the Fed awaits us. There are signs that the rise in US yields that have been an important driver of returns since the start of September and the dollar are topping out for now, and the news and data could confirm this.

Bond Funds & Mandates

In The Region
MENA credit was resilient last week. The JP Morgan MECI index was down 39 bps with credit spreads widening by 4 bps. Iraq was the best performer with a 55 bps gain while Lebanon was the worst one with a loss of 151 bps. In the GCC, UAE performed well with a loss of 7 bps compared to 33 bps for Oman and Saudi Arabia. Sukuk recorded a loss of 9 bps and sovereigns were the main detractor in terms of sectors with a loss of 50 bps.

The World Bank sees signs of recovery in MENA but instability remains a problem. It expects the region to grow by 3% in the next 2 years. Both MENA’s oil exporters and oil importers will benefit from a steady improvement in global growth, increased trade with Europe and Asia, more stable commodity markets, especially oil, and reforms undertaken in some of the countries in the region.

The earnings season continues with more releases over the past week. In Kuwait, the Commercial Bank of Kuwait posted a 22% yoy decline in net profits for Q3. Provisions and impairments were the main reasons. Generally bank results have been okay due to lower provisions even if revenue growth has been limited. Saudi Basic Industries Corp, in Saudi Arabia, reported a 10.7% rise in Q3. The profit was better than expected for the 4th largest petrochemical company. In general, petrochemical companies in the region were the winners of the quarter, while cement companies continue to disappoint. However, analysts expect the cement sector to benefit from the Saudi Arabia’s plan to build an entirely new, USD 500 billion city by the Red Sea.

The trade and diplomatic embargo on Qatar is escalating further ahead of the planned GCC summit. Bahrain will not attend the summit if Qatar does not address the issues, and suggested freezing Qatar out of the GCC if needed. Other reports indicate that the summit will be postponed.

The Institute of International Finance (IIF) remains positive on the economic outlook for Egypt, obviously noting that the implementation of reforms and improving security conditions are key objectives. The institution expect GDP growth to reach 4.9% in 2018 and inflation to slow down to 19.7% in 2018 after reaching 30% this year due to the currency devaluation and subsidy increases in electricity and fuel prices. The IFC (World Bank’s International Finance Corporation) announced that it will finance a USD 653 million solar power plant in Egypt to be part of the world largest solar park in the world.

Last week issuance was dominated by Arab Petroleum Investment Corporation (APICORP) and Abu Dhabi Crude Oil Pipeline (ADNOUH). The issues were well received by the market. APICORP’s 5-yr sukuk was priced at mid-swaps + 100 bps. ADCOP issued a USD 837 million 12-year bond at 3.65% and a USD 2.2 billion 30-year sinkable at 4.60%.

Mazoon Electricity Company, indirectly owned by the Government of Oman, rated Baa2 by Moody’s and BBB by Fitch is on the road ahead of a planned sukuk. Mazoon is the largest electricity distribution company in Oman by geographical area and number of customers. Market chatter for the weeks and months ahead includes Saudi Arabia issuing an international bond in Q1 2018, Jabal Omar mulling the issuance of sukuk, Al Ahli Bank of Kuwait considering a 5-year bond in early 2018, and Dubai Aerospace planning for a sukuk issue by mid-2018.

Out of Region
The JP Morgan EMBI Global Diversified (US dollar denominated, sovereign, emerging market bonds) lost 31 bps last week. Underlying US Treasuries lost 19 bps while credit spread related returns lost 12 bps. Africa was the worst performing region with a loss of 79 bps and Latin America was best with a loss of 7 bps. Venezuela, Mongolia and Tunisia performed well with an average gain of 286 bps, while Belize, South Africa and Turkey performed poorly with an average loss of 286 bps. Venezuela’s state run oil company made an USD 842 million payment related to its bond due last Friday for which the market expectation was very low. High grade bonds performed slightly better than high yield.

For the corporate sector, the CEMBI Broad Diversified (US dollar denominated, corporate, emerging market bonds) lost 23 bps. Spread related returns were minus 13 bps while underlying US Treasuries lost 11 bps. Asia was the best performing region with a loss of 12 bps, Europe was the worst with a loss of 66 bps. Pulp and Paper was the best performing sector with a gain of 3 bps, Consumer was the worst one with a 54 bps loss.

In the local currency markets, the JP Morgan GBI-EM Global Diversified index was down 55 bps in US dollar hedged terms last week. Currency returns were also negative with the unhedged returns recording a higher loss of 217 bps. Middle East and Africa was the worst performing region with a loss of 158 bps, while Europe was best with a loss of 39 bps in hedged terms. Chile was the best performing country with 39 bps gain in US dollar hedged terms. A market friendly, economic agenda unveiled by Presidential candidate Pinera was well received by investors. Pinera currently leads in the polls.Poland and Hungary also performed well with 12 and 7 bps gains respectively in US dollar hedged terms. Despite the improved macroeconomic environment in Poland, the ongoing conflict with EU institutions remains a source of concern. The Hungarian central bank said it was considering unconventional measures to ease monetary conditions further to which market reacted positively. On the laggard side, Argentina was the worst performer last week with a loss of 206 bps in US dollar hedged terms, the markets remain sceptical despite the government’s strong gains in the mid-term elections which pave the way for more reforms. South Africa and Turkey also performed poorly with 158 and 156 bps losses respectively in US dollar hedged terms. A review of the medium-term budget statement showed that the South African government has no clear plan regarding the deficit or how to stabilize debt, further increasing the likelihood of a downgrade. In Turkey, the central bank revealed a hawkish tone in its policy guidance with rising inflation expectations due to lira weakness.

In FX markets, most EM currencies experienced a loss over the last week with the strengthening of the US dollar. The notable laggards were the South African rand, Turkish lira and Colombian peso.

Other news in countries of frequent interest to us included the Indian government announcement that it will inject INR 2.11 trillion (USD 32.4 billion) of capital into public sector banks over the next two years, accompanied by reforms, aimed at sorting out the banks’ troubled balance sheets, improving their functionality and meeting Basel III requirements. In Turkey, the government refuted earlier reports that six banks might face fines in the billions of dollars by US authorities for alleged violations of Iran sanctions, helping the market to steady towards the end of what was a tough week.

The Funds
Our internal systems show that MENA Bond Fund (MBF) was down 31 bps last week to 27th October. The Bloomberg USD UAE Index was down 6 bps and the JP Morgan MECI (Middle East Composite) was down 39 bps, so MBF in line with the lower end of the market. According to the 26th October NAV, MBF was up 3.92% year-to-date. The yield of the fund is 4.45%.

According to our internal systems the Sukuk Income Fund (SIF) was down 11 bps in the week to 27th October. The JP Morgan MECI Sukuk was down 9 bps and the Dow Jones Global Sukuk Index was down 8 bps, so SIF was in line with the market. The 25th October NAV shows that SIF was up 1.94% year-to-date. The profit rate for the fund is 4.31%.

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