GCC sovereign bond yields have been rising moderately in recent months with the pace having gathered momentum over recent weeks (chart 1). The company views that the trend is likely to continue rising in the near term for two key reasons:
Rising US Treasury yields. Higher GCC bond yields, in part, reflect a rise in underlying US Treasury yields. Indeed, investors have started to price in more aggressive interest rate hikes by the US Federal Reserve (Fed), with 10 year Treasury yields surpassing 3% for the first time since 2014. The company continues to expect the Fed to raise interest rates by another 50bps this year, which will push up underlying US Treasury yields and with it, GCC yields will move up in tandem given the USD pegged exchange rate regimes.
Heightened geopolitical tensions. Higher GCC bond yields are a function of the heightened geopolitical risk premium that is now embedded into markets given the tensions in Syria as well as the prospect of the imposition of Iranian sanctions. Whilst geopolitical speculation seemed to be slowly ebbing out of markets given the relatively muted US coordinated “one-and done” airstrikes in Syria, geopolitics is once again taking the driving seat in propping up oil prices, with the focus now on the Iranian nuclear accord. Their baseline scenario was that President Trump would not sign the nuclear related waiver extension on 12 May – a decision which would either lead to a snap back of statutory sanctions put in place by Congress, and/or other restrictions on individuals or corporates. GCC views that markets haven’t fully priced in Iranian sanction risks given the lack of clarify around the articulation of the size and magnitude of the imposition of sanctions. Despite higher oil prices, there has been a widening of GCC spreads in recent months. This relationship is particularly strong for Saudi Arabia, wherein Saudi spreads over Treasuries have been widening, alongside higher oil prices (chart 2).
Indeed, the precipitous rise in oil prices in recent weeks (now at a three and a half year high), with what appears as a new soft normal of Brent above USD70/b and WTI above USD65/b, is moving in tandem with higher GCC yields. Looking ahead, if we are right in our call for oil prices to drop back as geopolitical risks ebb out of the market, with markets eventually focused back on fundamentals (our thesis remains that markets are caught in oversupply which will lead to a correction in oil prices), then GCC bonds are likely to continue widening.