It’s been a recurrent idea in this space that not only did benchmark bonds have only one way to go this year but that Middle East bonds and sukuk would inevitably follow.
That view was based on a set of beliefs as to (i) the unsustainability of the US Federal Reserve’s monetary easing programme, (ii) the market’s high degree of dependency on it, and closeness to a logical peak, (iii) a reading of economics that does not chime entirely with the mainstream policy notion that inflation and growth are simply functions of each other, and (iv) both emerging and frontier markets being to a considerable extent marginal plays according to the vast scale of international liquidity flows.
Who’s to say to what degree all four strands of the argument bear scrutiny?
Certainly, the very difficulty confronted by those authorities, with their stimulus measures to spur recovery, creates tremendous support for the bond market, with the data announcements still mixed.
The more so when you consider that participants are liable to greet any concerted pick-up by fleeing from bonds and thereby checking that same recovery by way of higher long interest rates.
In addition, there is the reaction of global supervisors to the discovery that sovereign bonds are not ‘risk-free’ -- namely to oblige the financial sector to hold more of them (identified as ‘financial suppression’), at sub-zero real rates of return -- which provides even further underpinning for bonds.
Still, what can hardly be argued against is that June saw a decisive shift away from bonds, triggered by the Fed’s remarks on policy tapering, which have since been substantially retracted in light of the market response, leading to a notable rebound (itself only emphasizing the relationship) in July.
A research note from Rasmala confirmed the contagion effect: “the risk run-off after the US Federal Reserve announced the possibility of scaling down its bond purchasing programme spread throughout the markets globally”, it said, rightly nominating the key point while verging on understatement.
Investment strategists had to take note of the extraordinary amount of capital flight from emerging markets, whose convincing story over many years was deemed by many to have run its course. Indeed frontier markets -- such as much of the Gulf (although the UAE and Qatar are due to graduate to emerging status) – have demonstrated comparative resilience through this period, and much of the year.
Societe Generale, for instance, reflected on the ‘exogenous factor’ of the sudden turnabout in the US upon the Fed’s “tapering talk”, i.e. that it was not domestic fundamentals which had in any way been responsible for the change in direction and the huge outflows seen.
Indeed, as much as anything, the so-called ‘technicals’ (the breaching of sensitive chart points) was cited as driving the market, again removed from issues of innate creditworthiness or economic performance.
That said, political risk in Mena, most evidently in Egypt, and the financing needs of key emerging economies such as South Africa and Turkey, had played a reinforcing role, and the dramatic fallout among Asian nations had been prompted as much by the “potential drag” from slower Chinese growth.
The upshot of this episode, though, sparked by foreign influences, was that while it was the most inherently financially exposed (high-yielders such as Indonesia and India) which did underperform, and certain regional, emerging-market credit appeal otherwise remained “attractive”, nevertheless the bank saw “no catalyst for a resumption of inflows”.
Whilst events have a habit of moving on, often in unexpected ways, the point was well made: markets are detached from the economies they are supposed to relate to, in time and trend, and no investor can endure profitably without that understanding.
As to Gulf credits in particular, research by Standard Chartered has found that they did outperform during the sell-off, exhibiting low correlations with other emerging market regions and therefore offering not only “diversification amid volatility” in a portfolio mix but also “defensive credentials” (see table).
Even so, the sukuk and shorter-dated bonds that the Bank highlights as safe havens (buoyed by what could correspondingly be termed the ‘endogenous’ factor of dedicated local liquidity) were only relatively so, given the dubious backdrop in US Treasuries to which they “remain susceptible”.
Covering similar ground, Arabia Monitor has examined the extent to which spreads might absorb a rise in Treasury yields in this second half of the year. Anticipating volatility, the research firm advises that, whereas investors might gravitate to apparently safer instruments in those conditions, in fact “in light of Mena’s unique dynamics, a mix of low-beta, high-beta and relative value credits” might be a favoured strategy, based on historical analysis.
In other words, the regional market does have a distinct offering. But the first half of 2013 demonstrated the limits to that distinction in absolute terms. Bonds could yet be in for a rough ride.