MUSCAT, AUG 20 - Benchmark global bond yields continued to trend down in 2Q19 amid ongoing trade tensions, central bank dovishness and signs of slowing economic growth, according to a report by NBK’s Research Department.
GCC bond yields tracked their global counterparts lower and indeed saw steeper declines partly on increased demand due to EMBI index inclusions.
Investors appeared to be relatively unswayed by recent geopolitical tensions in the Gulf, though a further escalation or alternatively falls in oil prices and revenues that jeopardise the fiscal situation pose a downside risk to GCC fixed income markets.
Meanwhile, regional debt issuance hit a record $40 billion in 2Q19, dominated by sovereigns and quasi-sovereigns and led by Saudi Arabia.
International yields fall on trade, Fed rate cut
Ongoing trade tensions, weaker economic data, low inflation, and interest rate cut prospects saw benchmark global yields fall in 2Q19. The declines were led by US 10-year treasuries, which fell 41 bps q/q to 2.00 per cent as of the end of Q2. This resulted in a more pronounced yield curve inversion, with a spread of 12 bps between the 3-month and 10-year yields, which has since widened to 32 bps as 10-year yields sunk to a three-year low of 1.68 per cent as of mid-August.
A combination of low inflation and concern over the economic growth outlook due to trade factors could exert downward pressure on longer-term yields going forward, but Fed policy will also be key. While the central bank delivered a rate cut of 25 bps in July as expected, it also hinted that it might not be the start of a broader easing cycle.
A more neutral Fed stance might cap further declines in US treasuries in the near-to-medium term, though futures markets are still pricing in at least one more interest rate cut this year given the escalating US-China trade dispute.
Meanwhile, weaker Eurozone growth, particularly declining manufacturing and exports in Germany due to the softer external climate, caused the 10-year German bund yield to cross into negative territory, declining 25 bps q/q to -0.33 per cent as of the end of Q2 — lower even than Japan — and further to -0.61 per cent by mid-August.
Contributing to the decline, the European Central Bank has adopted an increasingly dovish policy stance, boosting the possibility of a rate cut and mulling the reintroduction of quantitative easing. UK gilts also suffered fairly steep declines (-25 bps to a record low of 0.5 per cent), amid uncertainty surrounding Brexit and the resignation of prime minister Theresa May, replaced by Brexit hardliner Boris Johnson. Finally, Japanese JGB yields were the least affected by adverse global events, down only 7 bps q/q.
GCC yields see steeper declines
GCC yields on the whole saw steeper declines than their global counterparts, influenced by similar factors but also higher starting points for yields, Brent oil prices reaching above $75/bbl mid-quarter (though they have since fallen) and bond index inclusion.
Declines in medium-term (i.e. 7-8 year) GCC sovereign yields were led by Saudi Arabia, Kuwait and Abu Dhabi, down 65, 61, and 60 bps respectively in Q2. Demand for Saudi debt may have been boosted by Saudi Tadawul’s launch of bond and sukuk trading in April, while the UAE debt market was helped by the enactment of a debt law in late 2018 and the establishment of a debt management office which has improved regulation, access and transparency for bond investors. Kuwait’s decline in yields was helped by its strong credit rating and low existing debt levels, partly due to a lack of new issuance.
Regional demand has also been supported by the imminent inclusion of multiple GCC sovereigns in the JP Morgan Emerging markets Bond Index (EMBI). With $300 billion in assets under management and an assigned GCC weight of 11.3 per cent in the EMBI index, the region is estimated to receive approximately $30 billion in fund inflows, with more than half going to the larger debt markets of Saudi Arabia and Qatar.
Looking forward, GCC yields will continue to be influenced by global yields, which as described above have moved lower on growth concerns. However, declines in GCC yields could be limited if weaker world growth causes oil prices to fall, implying larger fiscal deficits and funding requirements. A further or sustained flare up in regional geopolitical tensions involving Iran could also underpin GCC yields.
Regional issuance hits fresh record in Q2, 2019
Amid lower yields, GCC bond issuance surged to a record $40 billion in 2Q19, breaking the previous high of $32 billion recorded in 1Q19 and paving the way for a strong year overall. This lifted total outstanding debt (foreign and domestic) to $501 billion at the end of Q2 from $478 billion in Q1. Issuance was dominated by sovereigns and quasi-sovereigns, with funding for strategic investments by sovereign wealth funds and state-owned enterprises a strong driver. In addition, a large volume of maturing debt has likely helped ramp-up new issuance. Some $43 billion in maturing debt is scheduled for 2019, of which $28 billion had matured as of early-August.
The bulk of issuance in Q2 came from Saudi Arabia with $26.8 billion. This included a jumbo $12 billion from Saudi Aramco as it looks to foster relationships with international investors ahead of its IPO scheduled for 2021 and in light of its plans to purchase a stake in SABIC. Also of note, Oman tapped international debt markets for the first time this year in July, with a successful $3 billion issue despite concerns over its fiscal position.
Meanwhile, a rise in issuance from the region’s financial firms was supported by a reported surge in mergers and acquisitions, especially in the UAE and Saudi Arabia.
With global and regional borrowing costs already low and perhaps set to decline further, issuance could remain strong for the remainder of the year. Moreover, foreign investor appetite for regional paper remains solid, and GCC borrowing needs are supported by expansionary budgets and the recent drop in oil prices if sustained.
(Credit: NBK Research Department)
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