9 factors that may affect demand for Gulf bonds

Rising economic growth will boost investor sentiment and help improve the bid for Gulf Cooperation Council (GCC) bonds, Emirates NBD said in a new report.

The year-to-date total return on Barclays Bloomberg GCC Bond Index has been a loss of 2.12 percent, mostly attributed to the rising benchmark US Treasury (UST) yields.

Besides, the recent sell-off in emerging market (EM) bonds on the back of increasing risk aversion arising from strengthening dollar and increasing trade tensions have made GCC valuation attractive on a historical basis, the report added.

Despite several risks continue to lurk on the horizon, the bank believes investors are looking at the GCC bonds favourably, in light of following factors:

1) Rising benchmark yields are becoming a manageable risk

The Fed has raised interest rates seven times by a total of 175 basis points (bps) since December 2015. A 50 bps increase in yield on 5-year benchmark USTs can obviously cause bond prices to fall; however, the fall can be cushioned by the current average 4.5 percent running yield on GCC bonds.

2) Stronger dollar and capital outflows will affect EM bonds

The trade war between the US and China has left financial markets in a conundrum. EM currencies have come under pressure and capital outflows are evident. However, GCC bonds are better placed than their EM counterparts given that there is no local currency debt market in the region and currencies are generally pegged to the dollar.

3) Rising oil prices are a credit positive

Oil prices have more than doubled from a low of $28 per barrel in early 2016 to over $79 per barrel now. Though higher oil prices have not translated into tighter credit spreads so far, they do provide a stable platform for spread tightening over time.

4) Rating downgrades have plateaued

More than two thirds of GCC bonds are issued by sovereigns and sovereign-related entities. Though Abu Dhabi and Kuwait based issuers remained largely unscathed, bulk of other issuers faced rating downgrades due to weakening credit profile due to lower oil prices during 2014 to 2017. However, this trend seems to have bottomed out.

5) Economic growth in GCC is expected to improve

With oil production set to increase and GCC governments loosing purse strings to stimulate economic activity, GDP growth in the GCC region is expected to increase from weighted average of 0.1 percent last year to 2.0 percent this year to 3.3 percent next year.

6) New bond supply is expected to slow

Since oil revenues are likely to be higher than budgeted $55 a barrel, GCC sovereigns are unlikely to need additional debt to fund budget deficits which will reduce the supply of new bonds in the region.

7) GCC credit story is currently underappreciated

In the last two years, GCC governments have improved their debt management functions, enhanced disclosures, controlled corruption, streamlined their budgets, enacted reforms and modernized cultures. Rising oil prices have helped to cut budget deficits and current account balances have returned to surpluses.

8) GCC bonds are attractive on relative value

GCC sovereigns are currently trading noticeably cheaper than their similar rated global peers. Value hunters will eventually look to close this gap.

9) Bahrain is likely to get support from its neighbours

While investors remain wary of the contagion risk if Bahrain was to default, Saudi Arabia, the UAE and Kuwait have announced plans to support the Bahraini economy.