Gulf Arab bonds, which were headed for their worst year since the financial crisis, may recover some of their losses in the last quarter after crude climbed to a four-year high and they were added to a key index.
Oil, the life-blood of most Gulf economies, rose above $82 (Dh301) a barrel this week, the highest since November 2014, and some traders are betting it will advance to $100 as US sanctions on Iran curb supply. Gains in oil will likely filter through to bond market gradually.
"The strength in oil still isn't totally reflected in the market because of the significant supply pipeline that
resumed after the summer, and is expected to continue until early December," said Zeina Rizk, a director of fixed income asset management at Arqaam Capital. "If we see currency volatility in emerging markets, especially with oil being where it is, the GCC is better off compared to the rest of emerging markets given
that the currency is pegged."
Gulf Arab debt will also get a boost after JPMorgan Chase said Saudi Arabia, the United Arab Emirates, Kuwait, Qatar and Bahrain will become eligible for inclusion in its emerging-market bonds indexes from the end of January, potentially attracting billions of dollars in passive inflows.
That, together with the gain in crude prices, could help ease declines for a JPMorgan index that tracks the region's bonds. The gauge fell 3.5 per cent so far in 2018 and was headed for an annual drop of 4.8 per cent, the biggest in a decade, amid geopolitical headwinds in the region and diminishing appetite for
risky assets. It will only be the third year of losses for the index since the end of 2008.
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Rising borrowing costs in the US hasn't helped. The Federal Reserve on Wednesday increased a key interest rate by a quarter point, and central banks in Saudi Arabia, the United Arab Emirates, Qatar and Bahrain followed.
The inclusion of Saudi Arabia, Qatar, the UAE, Bahrain and Kuwait in JPMorgan's bond indexes may lead to about $30 bn in inflows, Jean-Michel Saliba, an economist at Bank of America Merrill Lynch for the Middle East and North Africa, said in a note in August. Credit spreads on bonds from Qatar and
Saudi Arabia could tighten by another 20 basis points on flows, while the upside in Kuwait and Abu Dhabi is lower, he said. Bahrain is likely to be the biggest beneficiary.
"This decision is the most important factor to drive the GCC bond market in the coming months," said Oksana Reinhardt, an executive director for emerging market strategy at SMBC Nikko
Capital Markets in London. "The inclusion of GCC countries is a massively positive price supporting driver for the credits."
While Gulf bond prices will be supported by the index inclusion, not everybody expects higher oil prices to improve spreads.
"A material portion of the Gulf issuance to be included in the index is high grade, where there is not a significant amount of room for further credit spread compression, particularly in the short end of the curve," said Doug Bitcon, a portfolio manager at Dubai-based investment bank Rasmala. "A key
beneficiary will be a higher beta name like Bahrain, which has sizable issuance in the market and is enjoying a recent change in investor sentiment due to the higher oil price and what we believe to be probable GCC financial support."
Saudi Arabia and the four other Gulf Arab countries will represent about 11.2 per cent in two emerging market bond indexes that track $111bn in face amount outstanding from 15 eligible issuers, JPMorgan said on Wednesday. Spreads for both gauges are expected to tighten 21 basis points and 26 basis
points, respectively.