Last month was challenging for global risk assets, with many major equity indexes having their worst post-crisis start of the year, although they ended the month on a more positive note.
Continuing concerns about commodities and emerging market growth – particularly China’s economic strength – sent equity markets sharply lower. Emerging-market equities generally underperformed developed-market counterparts in this environment. Oil prices dipped to 2008-09 financial crisis levels, after the supply-and-demand dynamics underlying much of the energy sector’s volatility in 2015 became exacerbated by the potential effect of Iran as a new market participant.
Benchmark yields globally were the major beneficiary in this environment, particularly after the Bank of Japan enacted a negative interest rate to further stimulate the economy and reach its inflation targets. This led to a fall in the yen, effectively erasing its previous rally, and helped to drive a substantial gain in the US dollar, while yields on 10-year US Treasuries fell by about 39 basis points.
Globally, the IMF revised its growth outlooks for this year and 2017, by 0.2 percentage points downwards in each case, with 2016 projected growth now at 3.4 per cent and 2017 at 3.6 per cent. The fund also stated that any pickup in economic growth was likely to be gradual, especially for developing economies. In a climate of risk aversion, fixed-income markets benefited from a general decline in yields, although a widening of spreads caused declines in high-yield benchmarks. In this environment, emerging market fixed-income securities generally underperformed, with the JP Morgan Emerging Market Bond Index Global Diversified (EMBIGD) posting a -0.17 per cent return, while the Citi World Government Bond Index gained 1.31 per cent, both in US dollar terms. The Markit iTraxx Crossover Index, a barometer of stress in sub-investment-grade credit markets, showed an increase in January, reflecting the rising uncertainty and downturn in investor sentiment.
The Citi Mena Broad Bond Index posted a decline in January, reporting a return of -0.87 per cent and underperforming the EMBIGD, while the Dow Jones Sukuk Index remained fairly flat. The IMF’s downwards revisions of global growth included downwards adjustments for the economies of the GCC.
During 2015, governments in the GCC region began to enact financial reforms in response to the declines in hydrocarbon prices, but also to diversify and strengthen their respective economies. Such moves include some reductions in public spending, eliminations of some subsidies and increases in taxation. More recently, government ministries in Saudi Arabia have been exploring options for the privatisation of hospitals and schools.
While these and other reforms have been deemed necessary by most market observers, we also note that these initiatives will have a negative effect on short-term growth for these economies, particularly this year.
In the GCC, the principal policy response to falling oil prices has been the utilisation of financial buffers in a countercyclical manner. However, it is important to note that this response has also been followed by stricter financial discipline and consolidation. While these moves are likely to generate longer-term benefits, the short-term effect will likely be a cooling of economic growth.
World growth is also weakening for the year ahead, as the IMF revisions indicate, perhaps placing more importance on the medium- and long-term value of continuing economic reforms to better position the GCC region for when global conditions improve. We view the introduction of taxation and changes to energy and utility costs – such as the increase in petrol prices in Saudi Arabia – as positive moves, and as representing greater progress than the markets had discounted overall one year ago.
The sensitivity that GCC fixed income has exhibited to oil prices in recent months, resulting in some underperformance, is largely sentiment-based and represents a temporary dislocation, in our view.
As we have stated in recent commentaries, the asset class has low direct exposure to oil, even in comparison to other regions and markets that are characteristically less tied to energy commodities. Emerging-markets bond performance and movements in investment-grade yields tend to show stronger longer-term correlations with GCC fixed income.
Mohieddine Kronfol is the chief information officer for fixed income and global sukuk at Franklin Templeton Investments (ME).
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