GCC debt mar­kets yields con­tinue to de­cline in Q3

NBK ECO­NOMIC RE­PORT

Kuwait Times - - BUSINESS -

In GCC debt mar­kets, yields con­tin­ued to de­cline in 3Q16, driven largely by an im­prov­ing credit out­look and higher oil prices. GCC yields also ap­peared to ben­e­fit from the search for yield, with spreads to in­ter­na­tional bench­marks tight­en­ing.

US bench­mark yields were lit­tle changed dur­ing the quar­ter. GCC debt is­suance was strong in 3Q16, dom­i­nated by sov­er­eign pa­per, as gov­ern­ments sought to plug their growing deficits. Do­mes­tic of­fer­ings dom­i­nated sov­er­eign is­suance, as liq­uid­ity con­di­tions im­proved for most following large in­ter­na­tional bond of­fer­ings in 2Q16. Saudi Ara­bia saw liq­uid­ity con­di­tions de­te­ri­o­rate in 3Q16 on the back of its reg­u­lar do­mes­tic government debt of­fer­ings.

GCC and global yields be­gan the quar­ter un­der pres­sure following the UK’s vote to leave the EU, as in­vestors feared spillovers from the ref­er­en­dum. How­ever, swift ac­tion by the Bank of Eng­land, which in­cluded a 25 ba­sis points (bps) in­ter­est rate cut and an ex­pan­sion of its as­set pur­chase pro­gram, and a smooth tran­si­tion of the UK lead­er­ship pro­vided some re­as­sur­ance to in­vestors and helped sta­bi­lize mar­kets.

The sec­ond half of 3Q16 saw global yields driven by slow growth and asyn­chronous mon­e­tary poli­cies. In­deed, sus­pi­cions over the growing in­ef­fec­tive­ness of mon­e­tary eas­ing saw the ECB re­frain from tak­ing any ac­tion dur­ing the quar­ter, keep­ing Ger­man long term bunds rel­a­tively sta­ble. The BOJ, on the other hand, des­per­ate to “do what­ever it takes”, adopted new in­no­va­tive tools, such as “yield curve con­trol”, to help lift Japanese 10 years.

In the US, re­cur­ring mon­e­tary pol­icy in­ac­tion over the quar­ter pointed to the Fed’s De­cem­ber meet­ing as to when the bench­mark rate would be raised for the first and maybe only time in 2016. This helped edge 10 year treasuries up over the quar­ter.

In the GCC, yields tight­ened in 3Q16 as fis­cal out­looks ap­peared to im­prove and oil prices ben­e­fited from signs OPEC might cut oil sup­ply. The quar­ter saw a num­ber of re­form ini­tia­tives ma­te­ri­al­ized across the re­gion. Fac­ing deficits of over $120 bil­lion in 2016 and growing do­mes­tic liq­uid­ity pres­sures, author­i­ties across the GCC pur­sued fis­cal re­forms more ag­gres­sively. This helped in­crease the re­gion’s ap­peal to in­ter­na­tional cred­i­tors. It was boosted by OPEC’s de­ci­sion later in the quar­ter to cap the car­tel’s oil pro­duc­tion in an ef­fort to sup­port oil prices.

Im­proved risk pro­files cou­pled with in­ter­na­tional search for yield saw spreads of higher yield­ing sov­er­eigns to US treasuries tighten. The spreads of Dubai, Oman, and Bahrain, bonds to 5-year US treasuries de­clined by 20-42 bps. This was at the ex­pense of safer bets, such as Abu Dhabi and Qatar, whose spreads were rel­a­tively un­changed in 3Q16.

Re­gional credit de­fault swap rates also re­flected the im­proved risk pro­file. CDS rates were down across the board, with Dubai see­ing the largest de­cline at 39 bps on the quar­ter and down 146 bps from its peak in Jan­uary 2016. The rest fin­ished the quar­ter down be­tween 20 bps and 24 bps.

GCC debt is­suance was strong in 3Q16, led once again by sov­er­eigns. Gross is­suance to­taled $23 bil­lion dur­ing the quar­ter, with the stock of out­stand­ing bonds in­creas­ing by 23 per­cent in 3Q16 to $360 bil­lion. GCC sov­er­eigns dom­i­nated is­suance, adding $19.5 bil­lion worth of new pa­per in 3Q16.

The quar­ter saw do­mes­tic bonds dom­i­nate sov­er­eign is­suance, following a strong show­ing for in­ter­na­tional debt ear­lier in the year. Oman was the only sov­er­eign to tap in­ter­na­tional mar­kets for $2 bil­lion. The pre­vi­ous quar­ter’s large in­ter­na­tional of­fer­ings helped ease do­mes­tic liq­uid­ity for some. In­deed, Qatar re­turned to its do­mes­tic mar­ket in 3Q16 for the first time in 2016 to bor­row $2.5 bil­lion, in a sign that liq­uid­ity con­di­tions had im­proved following a $9 bil­lion in­ter­na­tional bond in 2Q16. Qatar’s in­ter­bank rate was steady at around 1.59 per­cent all quar­ter.

Do­mes­tic liq­uid­ity in Saudi Ara­bia did not fare as well, as do­mes­tic is­suance con­tin­ued to strain the mar­ket. Monthly do­mes­tic government debt of­fer­ings ab­sorbed the equiv­a­lent of $11 bil­lion from lo­cal banks in 3Q16 and $57 bil­lion since their in­tro­duc­tion last year. As a re­sult, the 3-month in­ter­bank rate rose to 2.35 per­cent, a level not seen since the 2008 fi­nan­cial cri­sis. In an ef­fort to ad­dress the tight liq­uid­ity, the Saudi Ara­bian Mon­e­tary Agency (SAMA) in­creased the max­i­mum lend­ing ra­tio to 90 per­cent and has of­fered banks cheap long term loans. Late Septem­ber, SAMA in­jected the equiv­a­lent of $5 bil­lion into do­mes­tic banks, ef­fec­tively ster­il­iz­ing the most re­cent government debt is­sue. De­lays to their in­ter­na­tional of­fer­ing, which was ex­pected some­time in 3Q16, did not help mat­ters. GCC debt is ex­pected to re­main ro­bust in the fi­nal quar­ter of 2016, with is­suers seek­ing to take ad­van­tage of the fa­vor­able global rates en­vi­ron­ment sup­ported by their im­prov­ing fis­cal sus­tain­abil­ity. We have al­ready seen Bahrain re-tap in­ter­na­tional mar­kets following a failed foray ear­lier in the year, while Saudi Ara­bia just com­pleted the largest emerg­ing mar­ket is­suance ever, col­lect­ing $17.5 bil­lion. Mean­while, Kuwait is ex­pected to is­sue an in­ter­na­tional bond in 4Q16 or 1Q17 that could raise up to $10 bil­lion. Weak fis­cal pic­tures are also ex­pected to push government-re­lated en­ti­ties to debt mar­kets, with Omani and UAE state owned firms ex­pected to lead the way. The on­go­ing crunch in do­mes­tic liq­uid­ity, if left unat­tended, may fur­ther see lo­cal banks turn to in­ter­na­tional mar­kets for fund­ing.

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