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ANALYSIS

Najla Al Shirawi and Ali Marshad

SICO investment note highlights market challenges

MANAMA, May 22, 2022

SICO, a leading regional asset manager, broker, and investment bank (licensed as a wholesale bank by the CBB), highlighted in a recent note to investors the challenges posed by high inflation and an aggressive US Federal Reserve rate hike schedule to the emerging and GCC capital markets. 
 
US Treasury yields surged by an average of 160 basis points this year, with market participants pricing in as much as 8.5 rate hikes for 2022, according to Fed Fund Futures. Rate hikes are driven by fears of rising inflation that reached its highest level in over 40 years at 8.5%, which in turn brought global bond prices down by 11.3%, according to the Bloomberg Global Aggregate Bond Index. 
 
The Fixed Income team at SICO, who were recently awarded MENA Fixed Income Manager and Sukuk Manager of the year, noted that inflation is now more embedded within the global economy, driven by supply chain disruptions and new structural dynamics in the labour market, due to the Covid-19 pandemic. Inflation concerns were exacerbated by the Ukraine-Russia war that sent commodity prices soaring, particularly in energy and agriculture. Oil prices rose to as high as $140 in March to eventually settle in the +$100 range.
 
The US Federal Reserve has already raised interest rates by 0.75% this year, but, according to SICO’s Head of Fixed Income, Ali Marshad, the country will remain aggressive in tightening its monetary policy, based on statements made by the Fed. He now expects two 50 basis points hikes at the next two FOMC meetings and a further 25 basis points at the remaining meetings in the latter part of the year. 
 
“Lower inflation will not surprise investors, as what matters will be the pace of the decline and how services inflation behaves. As core goods inflation turns around and base effects kick in, we expect US core CPI to drop to 5.0% in Q3 2022 and 4.5% in Q4 2022. Yet, the possibility of stagflation along with policy rate uncertainty and the war tenure have led to a flattening of the yield curve, leaving a small difference between short and long-term rates” said Marshad. 
 
The 30Y treasury is currently at 3.05%, 10Y at 2.85%, while 2Y bonds are trading at 2.62%, reflecting different levels of inflation and growth expectations, usually the signal of a recession at the end of a hiking cycle and not at the start, according to Ali. 
 
“Even before the Ukraine-Russia war, Q1 2022 was turning out to be a volatile quarter, as inflation prints consistently surprised to the upside in every major geography. Central banks turned hawkish towards the end of 2021 and kept aggressively leaning into that message from the start of this year” said SICO’s CEO Najla Al Shirawi. 
 
“With that in mind, we have been maintaining a low duration stance in all our fixed income portfolios, which helped us outperform. The SICO Fixed Income Fund has been the best performing GCC Bond Fund in 2022, down only 4.2% compared to 10.1% by the Bloomberg GCC Bond Index,” she added.
 
Ali Marshad continued to highlight that high oil prices have particularly helped high yield exporters, such as Bahrain and Oman, to outperform. Data obtained from the March 2022 factsheet showed that the fund was 36% exposed to Bahrain and carried a low duration of only 4 years.
 
When questioned on the investment strategy going forward, Ali urged investors to preserve capital at good yields and eventually rotate into higher yielding fixed income securities from the GCC at the end of the rate hike cycle, especially with the stronger backdrop of regional markets, supported by healthy oil prices and a positive ratings outlook. “We like short-term exposures in high yield oil exporters, real estate, financials, and perpetual securities,” he advised. 
 
The SICO Investment note, however, warns that the GCC remains vulnerable to oil price shocks and emerging market sentiment. It cautioned investors on the possible negative effects of policy mistakes, as the US Federal Reserve looks to reduce its balance sheet by selling back bonds into the market, which could reduce liquidity and slowdown growth to the point of a recession. 
 
The note concluded that Investment Grade barbell strategies and credit specific plays in the short-term high yield space are some of the best recommended trades to navigate the current investment environment. – TradeArabia News Service
 



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