Middle East Debt: Gulf bonds to weather jump in US Treasury yields
A jump in US Treasury yields in the last few weeks has raised a grim possibility for emerging market bond investors: a sustained back-up in US yields that could sink the value of bond holdings. But compared to many other places in the world, the Gulf looks well-placed to weather such a storm.
Copyright Reuters, 2013
Because it has a big local investor base of cash-rich financial institutions, the region may quickly absorb any mass exit by foreign investors from its bonds.
And relatively high yield levels, especially for lower-rated bonds, give countries in the six-member Gulf Co-operation Council some protection.
"GCC debt markets will continue to grow and increasingly capture a higher share of international, emerging market and regional portfolios, regardless of the cycle of US interest rates," said Mohieddine Kronfol, chief investment officer for global sukuk and regional fixed income markets at Franklin Templeton Investments. The yield on 10-year US Treasuries has hit a high of 1.91 percent in January, some 30 basis points higher than its levels in early December. The yield was at a record low of 1.39 percent in late July.
The consensus among most banks and investment firms is that the yield is likely to reach 2.25-2.50 percent by the end of this year, depending on US economic growth. A faster rise cannot be ruled out.
Investors bought heavily into Gulf debt last year; total bond and sukuk issuance from the region exceeded $40 billion, up from below $30 billion in 2011. So in theory, a back-up of US yields could expose investors to substantial losses.
The most highly rated, longest-term Gulf bonds have started to react to the US move. For example Qatar's $1 billion, 6.4 percent bond maturing in 2040 yielded 4.06 percent on Thursday, up 8 bps so far this year and at its highest level since mid-October.
But yields on less highly rated Gulf credits have continued dropping to record lows. The yield on the $1.8 billion, 6.85 percent bond issued by Dubai's DP World and maturing in 2037 is 5.40 percent, down 18 bps from the end of 2012. DP World is rated BBB-, the last level above junk grade. The reason for the divergence seems to be that yields on lower-rated Gulf bonds are still far enough above US Treasury yields that they look attractive - and would not necessarily back up sharply if US yields rise further.
Georges Elhedery, head of global markets for the region at HSBC, the top arranger of bonds and sukuk in the Middle East last year, said that despite recent tightening, GCC bonds and sukuk still offered value compared to other emerging markets.
For example, Turkey, rated BBB- by Fitch Ratings, priced its debut $1.5 billion sukuk last year at a profit rate of 2.803 percent for a long five-year issue, well inside much higher-rated Qatari and Abu Dhabi credits.