Middle East bonds drop despite issuance surge

November 1, 2023, 12:33 PM

A screen displaying stock market index is seen at the Saudi stock market in Riyadh — A steep uplift was seen in hiring activity across the non-oil private sector, driven by robust demand and output expectations.

GCC Bond Index down 5.1% this year
Mena Bond Index fell 3.8%
Value of bonds issued soars

Middle East bond indexes endured a tough October, extending the losses for 2023 despite a bumper year for regional debt issuance.

The slump in the benchmarks mirrors a sustained surge in US treasury yields. Bond yields and prices are inversely correlated, while Gulf bonds are priced based on a spread over US treasury yields.

As such, the increase in 10-year treasury US yields, which topped 5 percent in late October, for the first time since 2007, has affected regional bond markets, said Abdul Kadir Hussain, head of fixed income asset management at Arqaam Capital.

“Either the spread must absorb some of the increase in US yields or the overall yields that Gulf borrowers pay rises,” Hussain said.

So far, this has not led to a one-to-one increase in GCC yields, Hussain explained; if US yields rise 10 basis points, part of that is absorbed by the spread narrowing so that GCC investment grade yields will increase only seven basis points, for example.

“So, net, there has been an increase in funding and borrowing costs for the GCC borrowers, but it’s not necessarily been lock-step with the change in US treasuries,” Hussain said.

The S&P GCC Bond Index was down 5.1 percent this year as of October 30 and had fallen 2.6 percent since September 30.

The combined par value (the value stated by the issuer) of the index’s constituent bonds was $267.8 billion. The average weighted maturity was 12.7 years, and the par weighted coupon – the return set against the issue price of the bonds – was 3.8 percent.

The broader S&P Mena Bond and Sukuk Index has fallen 3.8 percent this year to October 30, and lost 2.2 percent from September 30 alone.

Franklin Templeton wrote in a note on October 6: “After every sharp drawdown in fixed income, there have been strong recoveries. The outlook still supports an increase in allocations to higher-quality fixed income sectors, including GCC bonds, which look poised to better defend portfolios and provide attractive levels of income.”

Corporate bond issuance in the six-member GCC bloc in the first nine months of 2023 totalled $18.7 billion, up 66 percent versus a year earlier, data from Refinitiv shows. The number of bonds issued fell to 35 from 39 over the same period.

GCC sovereign bond issuance in the first nine months of 2023 was $15.2 billion, a five-fold increase compared with the prior-year period, Refinitiv estimates.

Worldwide scope

Last year was one of the worst for bond markets worldwide, so the increase in Gulf bond issuance in 2023 partly reflects pent-up demand from borrowers who had previously delayed issuing debt until conditions improved.

Hussain said: “Now there’s actually yield in fixed income, in early 2023 there were good inflows into the asset class. Issuers saw they could issue bonds at good spreads, and even though absolute yields were higher, the spreads would be tighter.”

Gulf corporations have issued bonds this year for various reasons. These include to refinance existing debt, to fund capital expenditure and to maintain a presence in the market so that they can issue bonds more easily in the future should the need arise.

Hussain said: “If geopolitical problems remain relatively contained and we get more stability around the Fed’s interest rate outlook, we could have a pretty active fourth quarter for GCC bond issuance.

“It was widely expected that 2023 would be a record year for issuance in the GCC, and we could still achieve that, but if the Gaza conflict widens, then potential issuers will be warier.”

US interest rates are at historical highs of more than 5 percent and the Fed has indicated that rates will remain elevated.

Robin Marshall, director of global investment research at FTSE Russell, said that had led to a sell-off in long-dated treasuries, causing the yield curve to invert.

Normally, the longer the duration of a bond, the higher the yield that holders will receive, in what is known as the term premium.

An inverted bond yield curve can indicate a recession is imminent.

Marshall said: “It may happen eventually, perhaps in 2024 or 2025, but as a bond investor you might lose quite a lot by holding longer-duration bonds in the meantime.”

Geopolitical tensions may cause the spread between US and Gulf bonds to widen, although there are alternative scenarios.

Hussain said: “If the long end of the US treasury curve has become unanchored and investors are less comfortable owning long-dated US treasuries, then could GCC bonds become a quasi-replacement?”