Middle East varies tactics amid US treasury volatility

November 2, 2023

US Federal Reserve Chairman Jerome Powell. The Fed has maintained interest rates, with a knock-on impact on treasuries

US state debt known as treasuries
UAE increased treasury holdings
Saudi Arabia and Kuwait reduced levels

As expected, the US Federal Reserve kept interest rates on hold at its meeting this week. Always keenly watched in the Middle East because of its hefty reliance on the dollar, US interest rates are also important due to their influence on US state debt, known as treasuries.

Yields on US medium-dated government debt have soared to 16-year highs in response to the Fed’s hawkish stance on interest rates and worries over the country’s soaring deficits.

Such ructions matter to many Middle East countries, which are major holders of treasuries.

Over the past year, Middle East countries have pursued differing strategies in terms of their investments in US treasuries, official data shows.

In the 12 months to August, the UAE upped its treasury holdings to $68.3 billion from $48.2 billion. Saudi Arabia’s US treasury holdings fell to $112 billion from $122.1 billion and Kuwait’s dropped to $41.9 billion from $51.1 billion.

“Saudi investors may have done quite well by reducing their holdings, since yields have risen in this period, although clearly it will depend on the specific trades they’ve done and the exact levels at which they bought or sold,” said Robin Marshall, director of global investment research at FTSE Russell.

The increase in the UAE’s treasuries reflects its rising foreign currency reserves, said Abdul Kadir Hussain, head of fixed income asset management at Arqaam Capital, while Kuwait and Saudi Arabia have sold to help fund domestic spending

“If you’ve cut your treasury holdings earlier this year, you’re probably better off than those who have increased their exposure,” Hussain said.

Egypt’s US treasuries holdings plunged to $22.2 billion from $49.7 billion as it tried to support the ailing Egyptian pound, said Hasnain Malik, managing director of emerging and frontier markets equity strategy at Tellimer in Dubai.

Interest rate impact

Yields on 10-year US treasuries topped 5 percent in late October for the first time since 2007.

The US benchmark rate is 5.3-5.5 percent, while the Fed in September said it could still raise rates again this year and would keep rates in 2024 and 2025 higher than many economists had forecast.

“Yields haven’t moved up much for short-duration treasuries of late, but there’s some evidence of a capitulation trade in medium and longer maturities with many holders of such bonds deciding to sell,” said FTSE Russell’s Marshall.

If the Fed holds rates at above 5 percent for a prolonged period, there is little reason for investors to retain longer maturity treasuries, Marshall explained, because such debt possesses greater duration risk.

“If you’d held shorter maturities, you would’ve been better protected because these don’t react as much to rates going up,” he said.

This has led the yield curve to invert – normally, the longer the duration of a bond the higher the fixed coupon, or yield, that holders will require to hold the bond until maturity, to protect against higher inflation.

As such, the yield curve is normally upward sloping. Today, the opposite is true.

“The long end of the US treasury yield curve has become unanchored to some extent,” said Arqaam Capital’s Hussain.

History of Gulf US investments

Gulf crude exporters began investing substantially in long-term US government debt from 1974 following the end of Opec oil embargo in March that year, according to a report by Middle East Research and Information Project.

Then US secretary of state Henry Kissinger said he wanted Gulf states to buy long-term debt to “maximize their dependence on us”, while Saudi Arabia’s purchase of treasuries covered about 10 percent of the US federal spending deficit during the first two years of the Ronald Reagan administration, the report states.

Gulf holdings of US treasuries have risen and fallen roughly in correlation to long-term oil prices trends. Saudi’s treasury holdings were $1.3 billion in December 1974, but hit $39.2 billion in 1983 only to slump to $2.3 billion in May 2004. Saudi Arabia began re-increasing its holdings from June 2005, topping $100 billion in February 2015 for the first time.

The UAE first held more than $10 billion in US treasuries in June 2004. Its holdings peaked at $82.1 billion in February 2015.

During the era of low interest rates from mid-2008 to early 2022, yield-seeking investors were pushed to buy longer-maturity bonds or accept near-zero returns in short-dated bonds.

Now though, investors in longer term bonds are selling – thereby increasing yields because yields and bond prices are inversely correlated – and instead buying shorter-term treasuries, which have less risk and pay higher yields than the longer-term bonds they owned during the low-interest-rate era.

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