Shape of things to come for GCC credits

BLOOMBERG/JASPER JUINEN

By the time everyone reads this in September 2019, government bonds/Sukuk issued by Saudi Arabia and four other Gulf states have joined (or about to join) JP Morgan’s emerging markets bond indexes. Their inclusion was a gradual one.

It started on 31 January 2019 and it will be completed by 30 September 2019. By now these states should have realised more than original weightage in the index (i.e. to be accounted more than 11.4 per cent of the benchmark, a big change in one year). This is due to the fact that these states have issued more debts this year when the early figures over their weightage in the index were released early this year.

Less volatility

The move was expected to have attracted a total of around $30 billion of new foreign investment into their debt. But what is important, is that such credit, within the emerging markets (EM), is gradually being appreciated by international investors.

For example, we have seen that after Argentina’s poll result in August, vulnerable credits have suffered a shortlived sell-off in EM, while higher rated ones appeared unaffected (eg. GCC). While such credits have sustained geopolitical pressure in the region, the premium over EM peers are still there.

The lower UST yields, the higher GCC credits

The second factor that will give boost to GCC debt to outperform is the interest rate cut by the US Federal Reserve’s in July. This is an attractive rate environment for issuers as well as those who have issued debt in 2018 as such securities are probably is being traded at premium in the secondary market.

Further, the 30-year US Treasury yields have been seen traded below two per cent. This credit phenomena will drive prices of the 30-year (investment grade) GCC bonds into historical high levels (we are talking about bids around 116 for Saudi Government bonds at some point in July!).

This is due to the fact that yields are between 5-5.25 per cent. There is a correlation between UST yields and the spreads of GCC sovereigns as they both being used in the pricing mechanism of the debt instruments.

Euro denominated bond and Sukuk

It seems there is a spillover from Negative Euro yields and this is not a bad thing for highly rated GCC credits. It was reported that some institutional investors (i.e. Eurofocused investors) are offloading their euro negative yields holdings and are heading to attractive high-grade yields. This additional demand will prove positive to Investment grade GCC Credits who have issued Euro-denominated debt.