Gulf Bonds Under Stress as Lower-for-Longer Oil Outlook Sets In

  • GCC funding costs rising as U.S. Fed prepares to raise rates
  • Middle East bonds slumped most in more than two years in Nov.

The prospects of an extended decline in oil prices and higher U.S. interest rates are putting fresh strain on debt markets in the energy-rich Persian Gulf.

Bond losses in the Middle East accelerated in November, with prices dropping the most in two years, according to JPMorgan Chase indexes. The decrease came more than 16 months after crude began sliding from $115 a barrel to about $40 on Thursday. The yield on Qatar’s 2017 bond is up 43 basis points over the past month, while Bahrain’s 2023 paper rose 40 points. Fitch Ratings Ltd. downgraded Bahrain’s outlook to negative on Dec. 4, affirming the island kingdom’s BBB- credit rating at one level above junk. 

Brent crude, which tumbled 10 percent in November, fell Wednesday to the lowest in almost six years after OPEC abandoned any limits on output amid a global supply glut that has stretched budgets across the Middle East. Borrowing costs may jump higher as governments tap bond markets to bridge funding gaps. Traders speculate that the U.S. Federal Reserve will raise interest rates this month for the first time in almost a decade. Most Gulf Cooperation Council nations peg their currencies to the dollar.

“As we are approaching the first U.S. rate hike, volatility in the GCC credit markets has picked up,” Apostolos Bantis, a credit analyst at Commerzbank AG in Dubai, said in a Dec. 7 phone interview. “Considering that the GCC regional central banks are mirroring U.S. monetary policy, we should expect higher rates in this region as well.”

Fed’s Impact

Borrowers stand to pay higher costs as GCC countries -- also including Saudi Arabia, Kuwait, the United Arab Emirates and Oman -- raise interest rates in line with the Fed. Bantis said it’s not clear which of the regional group’s members would be the first to raise rates.

The growing need for financing may also boost borrowing costs. Lower oil prices are spurring governments and businesses to sell bonds to cover deficits and meet spending needs, and this puts bond prices under pressure in the six-nation GCC, according to Akber Khan, the director of asset management at Doha-based Al Rayan Investment, which manages about $900 million. 

Bahrain’s downgrade by Fitch came two months after Standard & Poor’s cut Saudi Arabia’s credit rating by one level to A+, the fifth-highest investment grade. Both ratings agencies said their decisions were influenced by the slide in oil prices and deeper projected budget deficits. 

Buying Opportunity

Saudi Arabia, the world’s biggest oil exporter, is a strong backer of Bahrain, the GCC’s smallest economy. GCC states hold 29 percent of global proven oil reserves, according to BP Plc data, and the group includes four members of the Organization of Petroleum Exporting Countries.

Bahrain’s avoidance of a cut by Fitch in its credit rating and the sell-off of its bonds last month may present a buying opportunity for some investors, according to Bantis.

“Despite the growing challenges, Bahrain debt remains attractive relative to similarly rated emerging markets credit,” he said. If the country’s rating were to be cut to junk, “Saudi Arabia continues to have sufficient ammunition and can afford to bail out Bahrain,” he said.

More ratings downgrades are possible for countries with weaker finances, such as Bahrain and Oman, Al Rayan’s Khan said. Ratings agencies assume oil remains weak, so crude prices and revenue must deteriorate more than the agencies are expecting for them to take action, he said.

“Lower-for-longer oil prices imply greater supply in bond markets because more countries and companies are going to need to raise liquidity,” Khan said in a phone interview. “They are likely to rely more on bond markets because banks don’t have the same liquidity they used to.”

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