* Ony top-rated, long-term Gulf bonds affected so far
* Gulf looks better placed than many emerging markets
* High absolute yield levels are protection
* Rich local investor base may support secondary market
* Oil price, geopolitics are vulnerabilities
By Mala Pancholia and Rachna Uppal
DUBAI, Jan 17 A jump in U.S. Treasury yields in
the last few weeks has raised a grim possibility for emerging
market bond investors: a sustained back-up in U.S. yields that
could sink the value of bond holdings. But compared to many
other places in the world, the Gulf looks well-placed to weather
such a storm.
Because it has a big local investor base of cash-rich
financial institutions, the region may quickly absorb any mass
exit by foreign investors from its bonds.
And relatively high yield levels, especially for lower-rated
bonds, give countries in the six-member Gulf Cooperation Council
"GCC debt markets will continue to grow and increasingly
capture a higher share of international, emerging market and
regional portfolios, regardless of the cycle of U.S. interest
rates," said Mohieddine Kronfol, chief investment officer for
global sukuk and regional fixed income markets at Franklin
The yield on 10-year U.S. Treasuries has hit a
high of 1.91 percent in January, some 30 basis points higher
than its levels in early December. The yield was at a record low
of 1.39 percent in late July.
The consensus among most banks and investment firms is that
the yield is likely to reach 2.25-2.50 percent by the end of
this year, depending on U.S. economic growth. A faster rise
cannot be ruled out.
Investors bought heavily into Gulf debt last year; total
bond and sukuk issuance from the region exceeded $40 billion, up
from below $30 billion in 2011. So in theory, a back-up of U.S.
yields could expose investors to substantial losses.
The most highly rated, longest-term Gulf bonds have started
to react to the U.S. move. For example Qatar's $1 billion, 6.4
percent bond maturing in 2040 yielded 4.06
percent on Thursday, up 8 bps so far this year and at its
highest level since mid-October.
But yields on less highly rated Gulf credits have continued
dropping to record lows. The yield on the $1.8 billion, 6.85
percent bond issued by Dubai's DP World and maturing in
2037 is 5.40 percent, down 18 bps from the end of
2012. DP World is rated BBB-, the last level above junk grade.
The reason for the divergence seems to be that yields on
lower-rated Gulf bonds are still far enough above U.S. Treasury
yields that they look attractive - and would not necessarily
back up sharply if U.S. yields rise further.
Georges Elhedery, head of global markets for the region at
HSBC, the top arranger of bonds and sukuk in the Middle East
last year, said that despite recent tightening, GCC bonds and
sukuk still offered value compared to other emerging markets.
For example, Turkey, rated BBB- by Fitch Ratings, priced its
debut $1.5 billion sukuk last year at a profit rate
of 2.803 percent for a long five-year issue, well inside much
higher-rated Qatari and Abu Dhabi credits.
The sukuk was yielding 2.49 percent on Thursday, almost
three percentage points below DP World with the same rating.
Bonds from Indonesia and the Philippines also priced tighter
than top-rated Gulf credits, giving Gulf issuers more leeway in
case of a substantial U.S. rate rise.
"Yield rather than spread continues to be the focus of the
majority of fixed income investors in the region," said Doug
Bitcon, head of fixed income funds and portfolios at Rasmala
Investment Bank in Dubai.
Another supportive factor for the Gulf is its large, rich
investor base, which typically bids for more than 50 percent of
bonds issued in the region.
Last year, Gulf issuers made a point of trying to diversify
geographically, so Gulf investors sometimes ended up getting
well under 50 percent of bonds on offer. But if foreigners were
to pull out, Gulf buyers could be expected to step into the
"Regional investors, especially the top financial
institutions, are unlikely to switch their holdings to UST
instead of high-grade or high-yield local paper, even if UST
offer better yields than now," said a Gulf-based analyst,
declining to be named under briefing rules.
"Regional liquidity will still chase Gulf dollar-denominated
The Gulf still carries substantial risks, of course. One
reason for its high yield levels is geopolitical risk; and it
would be vulnerable to any large, sustained drop in oil prices.
But as long as oil prices stay high, the region's economies
appear set to continue growing robustly, supported by heavy
government spending. This may set the Gulf apart from many other
emerging markets, where growth and credit quality could be
threatened if U.S. market rates rise too fast.
So the Gulf may outperform during any future crisis in the
U.S. Treasury market.
"If there is a sudden jump in risk-free rates, we're likely
to see new issuance at tighter spread levels as cash prices lag
- or do not fully reflect - rate movements," said Elhedery.
Some investors in Gulf bonds will be willing to accept lower
spreads above U.S. Treasuries as long as the yields they are
obtaining match their portfolio objectives, he added.