Global, GCC bond yields mixed in 2017

NBK ECO­NOMIC RE­PORT

Kuwait Times - - BUSINESS -

Global and GCC yields were mixed in 2Q17 as mar­kets re­acted to a more op­ti­mistic eco­nomic out­look, low in­fla­tion, and geopo­lit­i­cal risks. Is­suance in the GCC was strong but slightly slower than in 1Q17, led again by sov­er­eigns. Oman and Saudi were the only sov­er­eigns to is­sue in­ter­na­tion­ally. The on­go­ing rift with Qatar has in­creased the re­gion’s risk­i­ness and has ap­plied some pres­sure on Qatar’s liq­uid­ity. GCC pri­mary debt mar­ket ac­tiv­ity is ex­pected to be healthy in the sec­ond half of 2017.

In­ter­na­tional bench­mark yields were range­bound, trad­ing within a 28-35 bps win­dow in 2Q17. In­vestors bal­anced geopo­lit­i­cal un­cer­tainty and stub­bornly tepid in­fla­tion ex­pec­ta­tions against a grad­u­ally more pos­i­tive global eco­nomic back­drop. Over­all, yields trended down­wards for most of the quar­ter, jump­ing up twice through­out: once in mid-May on the back of strong eco­nomic data, and again to­wards quar­ter’s end on hawk­ish re­marks from global cen­tral banks (ECB, BOE, BOC). A fully priced Fed rate hike had lit­tle im­pact on mar­kets, with most GCC cen­tral banks fol­low­ing suit in sup­port of their USD pegs. Other ma­jor cen­tral banks stood pat.

US trea­sury yields drop

US gov­ern­ment 10-year Trea­sury yields were down in 2Q17, fin­ish­ing 9 bps lower at 2.35 per­cent, in spite of the Fed’s rate hike in June. Down­ward pres­sures emerged from weak to mod­er­ate eco­nomic data, from lit­tle progress on health­care and tax re­form, and from po­lit­i­cal/me­dia shenani­gans sur­round­ing the White House. This has un­der­pinned skep­ti­cism over fu­ture in­fla­tion mo­men­tum and the gov­ern­ment’s short-term pro-growth poli­cies. US 10-year yields ex­pe­ri­enced their largest daily drop in al­most a year (11 bps) on 17 May when Pres­i­dent Trump was ru­mored of hav­ing in­ter­fered with an FBI in­ves­ti­ga­tion.

Yields on 10-year Ger­man Bunds were up 14 bps in 2Q17, reg­is­ter­ing at 0.47 per­cent fol­low­ing the French pres­i­den­tial elec­tion and hawk­ish ECB state­ments. The emer­gence of pro-EU re­form minded Emmanuel Macron as France’s pres­i­dent saw in­vestors un­wind risk-off po­si­tions through­out the quar­ter, help­ing 10-year Bund yields rise. But weaker than ex­pected in­fla­tion data, which fa­vored pol­icy in­ac­tion dur­ing two ECB meet­ings held dur­ing 2Q17, tem­pered the rise in yields and pres­sured them down­ward. 10-year Bund yields would later ex­pe­ri­ence their largest in­crease since the US pres­i­den­tial elec­tion, jump­ing by 10 bps on 27 June, fol­low­ing re­marks made by ECB pres­i­dent Draghi. Mar­kets in­ter­preted his com­ments as sur­pris­ingly hawk­ish and fur­ther af­firmed what is now seen as a change in tone in the ECB’s out­look.

Qatar, Oman shine

Qatari and Omani yields jumped fol­low­ing in­creased geopo­lit­i­cal risks for the for­mer and fi­nan­cial risks for the lat­ter. The rest of the GCC sov­er­eign yields were down or lit­tle changed as they tracked US Trea­suries.

Qatar’s rift with neigh­bor­ing coun­tries saw yields on Qatari sov­er­eign bonds ma­tur­ing in 2021 breach 3 per­cent and fin­ish the quar­ter at a record high of 3.12 per­cent, up 45bps. The re­gional os­tracism of Qatar also re­sulted in Moody’s re­vis­ing its out­look to “neg­a­tive”.

Oman’s down­grade to lower than in­vest­ment­grade by S&P, on the grounds of weaker fi­nan­cial buf­fers, saw the yield on Omani pa­per due in 2021 jump up 40 bps in 2Q17. The lat­ter was ex­as­per­ated by weak­en­ing oil prices dur­ing the quar­ter and a still large fi­nanc­ing deficit.

The Fed­eral Re­serve re­mained the only ma­jor cen­tral bank tight­en­ing its mon­e­tary pol­icy, as it hiked its pol­icy rate again in 2Q17. The Fed in­creased its tar­get fed­eral funds rate by 25 bps to 1.00-1.25 per­cent in June. This was its sec­ond rate hike this year and oc­curred de­spite some­what weaker na­tional data. The Fed’s rate out­look, for now, still sees only three hikes in 2017. Mar­kets ex­pect the next move to hap­pen in De­cem­ber with close to 50 per­cent cer­tainty.

ECB, BoE hawk­ish

The ECB and the BOE turned hawk­ish late in the quar­ter in spite of dovish an­nounce­ments early on. The ECB’s of­fi­cial dovish pol­icy stance in 2Q17, sup­ported by weaker than ex­pected in­fla­tion data, came at odds with record set­ting PMIs and healthy GDP growth. Re­marks by the ECB at its 8 June pol­icy meet­ing and by ECB pres­i­dent Draghi on 26 June at an ECB con­fer­ence, how­ever, re­vealed a grad­ual ac­cep­tance of a more op­ti­mistic out­look. In­vestors in­ter­preted the newly pos­i­tive tone as a primer for mon­e­tary tight­en­ing. Mean­while, the BOE sur­prised by com­ing very close to hik­ing its pol­icy rate, with 3 of its 8 mem­bers vot­ing in fa­vor, on the grounds of ris­ing in­fla­tion­ary pres­sures. This was later sub­stan­ti­ated by hawk­ish com­ments made by BOE gover­nor Car­ney.

GCC cen­tral banks fol­lowed the Fed, rais­ing their pol­icy rates by 25 bps, with Oman and Kuwait be­ing the ex­cep­tions. The moves were in line with the need to sup­port USD pegs. As for Oman, this is the third time it passes on hik­ing its pol­icy rate, de­spite its peg to the dol­lar, and the first for Kuwait. How­ever, their cen­tral banks did hike repo rates, as they sought to pro­tect their pegs without hurt­ing do­mes­tic credit growth.

GCC is­suance eases

GCC debt is­suance eased in 2Q17 as the quar­ter co­in­cided with the holy month of Ra­madan but re­mained strong none­the­less. To­tal new is­suance amounted to $20 bil­lion com­pared to $26 bil­lion in 1Q17, driven al­most en­tirely by sov­er­eign ac­tiv­ity. Pri­vate sec­tor ac­tiv­ity was rel­a­tively weak in 2Q17; with banks ac­count­ing for most of it. To­tal out­stand­ing debt was up a healthy 11 bil­lion, to rest at $394 bil­lion.

Sov­er­eign ac­tiv­ity stayed strong dur­ing 2Q17 with $18 bil­lion in new is­suance, chiefly driven by Saudi Ara­bia and helped by Qatar, Oman, and Kuwait. Oman and Saudi were the only two to tap in­ter­na­tional mar­kets for a $2 bil­lion sukuk and a $9 bil­lion sukuk, re­spec­tively. The of­fer­ings were well re­ceived, even with Oman’s down­grade to be­low in­vest­ment grade, re­flect­ing the still strong at­trac­tive­ness of GCC debt. Qatar and Kuwait is­sued do­mes­tic debt to­tal­ing $3.5 bil­lion and $2 bil­lion, re­spec­tively.

The risk­i­ness of in­vest­ing in the re­gion has risen fol­low­ing the dis­pute be­tween Qatar and four Arab al­lies. CDS rates rose across the board as in­vestors di­gested the fall­out. Qatar was the worst hit, with its CDS rate ris­ing to 118 bps, up 48 bps on the quar­ter and the high­est it has been in a year. As for the rest of the tracked GCC sov­er­eigns, their CDS rates were up be­tween 5 and 13 bps.

Qatar liq­uid­ity

The rift has also stressed Qatar’s liq­uid­ity, with its 3-month interbank rate jump­ing 50 bps in 2Q17, as re­gional in­sti­tu­tions in the con­cerned coun­tries, both pri­vate and fi­nan­cial, shied away from deal­ing with Qatari banks. As for the rest of the GCC, interbank rates rose to ac­com­mo­date the June Fed hike, in­creas­ing be­tween 5 and 18bps.

GCC debt is­suance is ex­pected to re­main healthy for the rest of 2017, as sov­er­eigns con­tinue to seek cheap deficit fi­nanc­ing, but will in­creas­ingly face grow­ing risks. The geopo­lit­i­cal rift with Qatar has al­ready weighed on in­vestor con­fi­dence, and may ham­per fu­ture re­gional is­suance ac­tiv­ity, es­pe­cially if the dis­pute es­ca­lates or is drawn-out. The volatil­ity in cur­rent oil prices stands as an­other risk, with oil prices fail­ing to firm up fol­low­ing an ex­ten­sion to the OPEC agree­ment. The pick-up in global growth and the ex­pected rel­a­tive cheap­ness of the dol­lar may also di­vert in­vestors’ in­ter­ests to other debt mar­kets.

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