Gulf bonds hit the buffers amid global gloom

Observers in the Gulf must wonder what’s next to come from overseas markets. While local news improves with the support of key influences like real estate recovery or government commitments to infrastructure projects, the international picture still looks much less clever, in fact rather jaded.

Metaphorically, has the band stopped playing now, exhausted? Is all the froth of the Fed’s party spilling over again, making a mess?

Stock markets have predictably soured somewhat, having surged without the firm basis of tangible corporate performance or prospects through the summer.

The US dollar, oil and commodities have all slipped in the face of inadequate signs of continuing economic turnaround.

The reason for rising concern must be that the upbeat promise of repetitive financial injections by Western authorities to try to enliven economic growth is an experiment whose credibility may have nearly run its course.

Licence to act

Till recently, there has been a degree of licence given by investors, understanding that the possibility of deflation not only had to be overcome to evade disturbing debt dynamics, but also to give some leeway for state-sponsored reflation before inflation would kick in. That was the muddling through mentioned here a couple of months back.

Now, there has to be a growing suspicion that — dare I repeat a coinage of three years ago — Western policymakers are showing every sign of really not knowing what they’re doing; moreover, that more harm is being done than good. Some bad, even defunct, economics is being assiduously and expensively bandied around in an attempt to bypass the inevitable deleveraging after the bubble years.

Choosing inflation over deflation is one thing. Pretending that the government can itself choose inflation over unemployment and drive an economy’s growth is quite another — distinctly erroneous and dangerous. It’s as if Western policy leaders want to selectively learn the lessons of the 1930s, but not those plainly delivered by the experience of the 1970s.

Markets are, therefore, becoming increasingly bereft of confidence, in fact, downright concerned. In a world of incessant pump-priming, stagflation is the logical danger.

The nightmare scenario is that the bond market, till now standing reasonably firm, effectively underwritten in the West by the respective central banks, will throw in the towel.

Inadvisable monetary unity

Already, gold has rebounded again, picking up the same, relevant signals. Against the euro, it’s reached record levels as the Eurozone demonstrates to all remaining idealists that forcibly maintaining an obviously inadvisable monetary unity leads inexorably to political disunity, and recklessly to economic and social mayhem.

Never mind the rift between Germany and Greece; now, Spain is threatening to tear itself apart in the form of a Catalonian threat to seek secession from the rest of the country.

So much for continental solidarity, always a contrivance. At some stage, the troubles of the euro may grow sufficiently even to bail out the dollar’s reputation for a while.

In the midst of the accumulating wreckage, it is noticeable that Saudi Arabia is concertedly trying to keep oil prices in check, presumably fearing that the world will need all the help it can get.

At the same time, to the extent that the East remains exposed to the malign effects of its past mercantilist practices, i.e. the deliberate targeting of balance of payments surpluses, then the global economy could soon be in very serious trouble again.

It is all very well beating your competitors in net exports and, thereby, building reserves to re-invest, but eventually their deficits and diminished wealth inhibit their counterpart ability to keep paying in future, especially if the creditor country recycles its bounty in portfolio assets, and perhaps trophy assets, in the debtor country.

Fed’s sugar rush

Until mid-month, Gulf bond markets were pretty buoyant, feeding off the effect of the intense sugar rush from the Fed on US Treasuries, but also sweetened by inherently improving regional trends, both of liquidity and the background of ongoing restructuring.

Relatedly, Bank Audi research recorded a milestone in the contraction of CDS (credit default swap) spreads this week as Dubai’s credit risk touched a four-year low, in contrast with global comparison which has risen as far as Middle East risk has fallen in those terms this year (see table).

Regional brokers have reported slower conditions in the past week or two. Invest AD said Middle East credit markets had “taken a breather, with investors locking in some profit and accumulating dry powder for an expected flow of new issuance in the fourth quarter”.

Saeed Hirsh, Middle East analyst at Capital Economics, notes that Gulf bonds have not emerged unscathed from the dampening of mood. “The boost to risky assets [including those of Mena] following QE3 has largely faded,” he told me this week. The deterioration of sentiment towards US Treasuries is mainly but not wholly responsible, he surmised.

In any case, a pause for reconsideration is not only here, but also seems justified.