Dubai: GCC bonds are expected to recover in the second half of 2018, after a decline May following a sell off across the emerging markets in April and May, according to analysts.

“Year to date total return on Barclays Bloomberg GCC Bond Index has been a loss of 2.12 per cent, much in line with our expectations at the beginning of the year and almost entirely attributed to the rising benchmark US treasury yields,” said Anita Yadav, Senior Director and Head of Fixed Income Research at Emirates NBD.

GCC yields track US treasury yields. Elevated US treasury yields, and a stronger US dollar sparked a sell-off across several emerging economies and pushed yields higher over the past few months.

“The modest GCC bond outflows in March and April are likely to be temporary as GCC bonds offer solid risk-adjusted returns and foreign investors’ exposure is limited. Bond prices in the GCC fell in May, in line with the ongoing sell off in emerging markets assets. However, the sovereign spreads remain lower than most EMs as government financing needs have eased with higher oil prices,” said Garbis Iradian, Mena chief economist of the Institute of International Finanace.

The recent sell off in EM bonds on the back of increasing risk aversion arising from strengthening dollar and increasing trade tensions has made valuation attractive on a historical basis. Though several risks continue to lurk on the horizon, analysts said it may be time to begin looking at the GCC bonds favourably.

Economic growth in the US is at cyclical high and inflation is expected to increase from here. US Federal Reserve is set to raise its target rate by another 100 to 150 bps over the next two years.

“We think the US treasury benchmark yield curve in the longer end is unlikely to rise materially given the uncertain global trade outlook and increasing possibility of the US economic growth having peaked,” said Yadav.

While Fed has raised interest rates seven time by a total of 175 bps since December 2015, yield on 10-year US treasuries has only increased 60 bps from 2.26 per cent in December 2015 to 2.86 per cent now. Yields on 7-10 year part of the curve is unlikely to rise by more than 25-75bps even if Fed’s target rate was to increase by another 100 bps over the next 12 months.

GCC bond index has an average duration of about 6.5 years. A 50 bps increase in yield on 5-year benchmark US treasury can obviously cause bond prices to fall, however, the fall can be cushioned by the average 4.5 per cent running yield on GCC bonds now.

Capital outflows

The 3-month long trade war between largest economies of the world — US and China — has left financial markets in a conundrum. EM currencies have come under pressure and capital outflows are evident.

“In this environment, GCC bonds are better placed than their EM counterparts given that there is no local currency debt market in the region and currencies are generally pegged to the dollar. Barring oil, GCC countries do not export material amount of other trade items and therefore the trade tensions are unlikely to have much direct impact on GCC economies,” said Yadav.

Historically there has been strong co-relation between oil prices and credit spreads in the region. Oil prices have more than doubled from their low of $28/b in early 2016 to over $79/b now. Though higher oil prices have not translated into tighter credit spreads so far, they do provide a stable platform for spread tightening once the dust on geopolitical issues settles.

With oil production set to increase and GCC governments loosing purse strings to stimulate economic activity. Rising economic growth should boost investor sentiment and help improve the bid for GCC bonds.

“In view of lingering uncertainties relating to sanctions on Iran, military conflict in Yemen, diplomatic dispute between Qatar and its neighbours etc, GCC sovereigns are currently trading noticeably cheaper than their similar rated global peers. We expect value hunters to eventually look to close this gap,” said Yadav.