The Weekly Market Color
Publication Date : Saturday, May 25, 2013
The Weekly Market Color
Federal Reserve Chairman Ben Bernanke’s hint that there could be a tapering off of QE (quantitative easing) purchases as early as September led to a rout in the bond markets this past week.

Federal Reserve Chairman Ben Bernanke’s hint that there could be a tapering off of QE (quantitative easing) purchases as early as September led to a rout in the bond markets this past week.

Yields on U.S. Treasury bonds spiked higher as investors dumped U.S. Treasury bonds (price and yield move inversely) with the yield on the benchmark 10 year U.S. Treasury bond closing above the 2% threshold.

Fed Chairman Ben Bernanke hinted that a downward adjustment to the size of the current QE program could take place at one of the "next few meetings" of the FOMC (Federal Open Market Committee) if economic activity continues to improve.

Speculation over the possibility that the Fed may begin to wind down the current open-ended QE policy in which the Fed purchases roughly USD 40 billion of agency MBS (mortgage backed securities) and USD 45 billion of longer-term Treasuries each month has been rampant over the past few weeks.

Nevertheless, Bernanke’s off-the-cuff statement was still a surprise to the markets since his prepared testimony was a stout defense of the need for a highly accommodative monetary policy.

The minutes of the May 1 FOMC meeting corroborated this possibility; however, a reduction in the rate of purchases does not mean that QE is ending.

Global equity markets still remain near their all-time highs even as the Japanese Nikkei stock index exhibited a sharp correction on Thursday.

Importantly, while the sell-off in U.S. Treasury bonds (and commensurate uptick in U.S. Treasury bond yields) led to substantial declines in the valuation of corporate bonds, Sukuk holdings remain resilient.

The sell-off in bonds after Bernanke’s statement was exacerbated by weak data out of China and the massive sell-off in the Japanese Nikkei stock index.

Most conventional bonds were anywhere from 1 to 3 points lower in price across the board on a wave of selling, with dealers heavy on inventory, cash bond spreads gapped wider on minimal flows.

The recently tapped conventional Morocco bonds maturing in 2042 and the EBIUH perpetual bonds (“perps”) were almost 3 points lower each. Most players in the market, especially real money players who cannot hedge their interest rate exposure, were sellers of their bond holdings in what amounted to one-way price action.

The rare pockets of buying were seen from MENA and non-Euro / U.S. investors that are focused on Sukuks.

In Africa, South African bonds traded heavy with mainly sellers while Ghana confirmed that it will be issuing $1 billion of bonds in July.

The four new issues in the region were: Dar Al Arkan (Islamic), EBIUH perp, ADCB (Abu Dhabi Commercial Bank which issued USD 300 million of subordinated debt at a yield of 3.125% maturing in 2023) and a re-tap of the Morocco 2022s and 2042s.

Pricing and primary market allocations are starting to make a difference in secondary market trading, with the Dar trading very well (the paper was +1.5 points higher in secondary trading) on demand from Islamic accounts while the EBIUH perps traded very poorly as the deal was priced very tight and allocations went to “fast-money” accounts.

The silver lining is that the market action demonstrated that Sukuk paper is relatively more resilient than conventional bonds.

This bodes well for the IsDB’s planned public Sukuk issuance, slated for pricing on May 29 in London. At the IsDB’s annual Board of Governors meeting held in Dushanbe this past week a capital increase to roughly $150 billion was authorized.

As a reference point, the existing outstanding IsDB Sukuk paper complex (the 2014’s, 2015’s, 2016’s, and 2017’s) is virtually unchanged in price terms, even as conventional bonds are several points lower compared to where they were trading prior to Bernanke’s statement.  

The liquidity in IsDB paper is no less than that of other MDB (multilateral development bank) paper. There is a large, and growing, "captive" investor base for IsDB Sukuk paper so liquidity is as good as it gets on the bid side (i.e. when an investor is looking to sell the paper). 

Liquidity is only an issue on the offer side (i.e. when an investor is looking to buy additional increments of IsDB Sukuk paper in the secondary markets) as IsDB Sukuk paper is held tightly by investors and there are few willing sellers; that is a good "problem" to have, especially if one is an investor in IsDB paper.

Flows are relatively light in the global markets with the Memorial Day long weekend in the U.S. and the Bank Holiday long weekend in the UK.

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