Last week market focus was dominated by the unfolding events in the Middle East; where Bahrain and Saudi Arabia, and subsequently UAE and Egypt abruptly cut diplomatic ties with Qatar; alleging links with “terrorism and extremism”, and Iran. Oman and Kuwait, other members of the GCC remained neutral; with Kuwait leading mediation talks. Donald Trump also offered up Rex Tillerson to aid in the negotiation process; Tillerson has past experience within the Gulf region having dealt with the likes of Saudi Arabia as former CEO to Exxon Mobil. Mid-week, S&P moved to downgrade Qatar’s rating one notch to Aa3 (negative), bring it in-line Moody’s Aa3 rating. Fitch has maintained its AA (stable) rating suggesting that it is too early to see the true impact, if any, on the Emirate’s strong economy, stating the sovereign's ‘net foreign assets worth over 200 per cent of GDP mean that the sovereign credit profile is highly resilient to external shocks. As the situation evolves, our assessment will focus on effects on the sovereign's external and fiscal deficits’.
Qatar sovereign and quasi-sovereign bonds were roughly 10-25bps wider in spread over the week; so a lot more resilient than most market makers ha expected. This was partially offset by the gains in Saudi government and government-owned entities we hold. We will continue to monitor the situation this week, however, for the moment we are neither looking to buy nor sell out of Qatari holdings, instead maintaining positions with up to 4 credit notches protection, thus offering an attractive spread over similar bonds. With no new developments over the weekend, Qatar bonds have traded up so far today (at time of writing).
Elsewhere, former FBI Director Comey’s testimony was pretty much a non-event in the US; the dollar gathered steam into the end of the week, gaining 0.58% (DXY Index), but still close to pre-election low levels, and 10-year US Treasury yields nudged up 4bps over the week, to 2.20%. This week will see the release of the May monthly budget statement, where expectations are for a USD 87bn deficit. PPI and CPI readings will be released on Wednesday, CPI expectations stand at 0% mom thus 2% yoy, down from 2.2% previously. Retail sales data will also be of some interest; the control group reading (a component of GDP calculations) is expected to come in at 0.3%, up from 0.2% in April. The all important FOMC meeting follows, where we expect the Fed will move to tighten by 25bps, taking rates to 1%-1.25%; still historically low levels. The Fed is also expected to announce its plans on shrinking its balance sheet, to commence in September, and update economic and financial projections; core inflation for example may be revised lower. Finally, the end of the week will see a number of economic data prints, with the likes of housing starts, building permits, University of Michigan sentiment, and Empire Manufacturing for June, which is expected to come in at 5, from -1 previously.
In Europe, the ECB upgraded eurozone growth forecasts and kept rates on hold. Meanwhile, the UK elections were of much market focus into the second half of the week; the conservative party lost a number of seats and parliament ‘hung’ in the balance. The week ended with the announcement that the UK Conservative party reached a deal with Northern Ireland’s Democratic Unionist Party (DUP) for Theresa May to remain as PM and proceed with Brexit negotiations which are expected to be ‘softer’. Sterling swung around on Friday, falling as low as 1.2636 against the dollar intra-day, eventually settling at 1.2746 against the dollar, 1.10% lower on the week.
This week will see a continuation of CPI and PPI, and trade date across the UK and Europe, EC employment releases for April will also be of some interest. No doubt eyes will remain on the developments within the UK government. Theresa May will today come face to face at a gathering with her 1922 committee of backbenchers; a meeting which was brought forward a day. A number of reports have come out over the weekend and this morning suggesting May could be overthrown and replaced; George Osborne claims May is a ‘dead woman walking’, while David Davis and former Tory leader, Michael Howard have expressed the need for stability and togetherness stating May is the right person to continue the Brexit negotiations.
Away from politics, economic data releases from China were broadly positive. FX reserves beat market expectations, and remained above the USD 3tn level; as a result Beijing announced an increase in US Treasury holdings. Trade data beat expectations, with imports and exports up from April. Inflation numbers also came in pretty much in line with the market consensus, with for example CPI 1.5% yoy up from 1.2% previously. This coming week is a relatively quiet one for China data with the main feature being retail sales, which is expected to come in unchanged from April at 10.7% yoy.