Muhannad Mukahall
In recent months, financial markets have been focused on the rise in US government bond yields, particularly given the 10-year yield has reached 5%. This increase prompts questions about the trade-off between bonds and equities, the potential for further yield growth, and whether high yields could lead to significant consequences.
Those supporting bonds argue that the current 5% yield factors in a prolonged pause by the Federal Reserve at existing rates and a substantial real yield of about 2.5%, nearing levels seen before 2008.
On the other hand, sceptics argue that for the yield curve to normalise, the 10-year yield may need to surpass the Fed policy rate of 5.5%, especially in a scenario of a prolonged pause and a resilient US economy.
This contrasts with typical late-cycle trends where the yield curve normalises due to a sharp fall in short-maturity yields prompted by Fed rate cuts during an economic downturn.
Coupled with historic debt levels, sluggish growth, and political uncertainties, investors are presented with unique challenges. Despite these uncertainties, maintaining an overweight stance on developed market investment-grade bonds remains a strategic choice. This reflects confidence in the potential for yield curve normalisation, given historical performance patterns that show bond yields tend to peak not far from the peak in the Federal Reserve policy rate.
The landscape is further shaped by the transformative impact of new trade routes and economic agreements, redistributing power from developed to developing economies.
The recently unveiled India-Middle East-Europe Corridor (IMEC) serves as a testament to the ambitious drive of developing markets. Announced at the G20 summit in India in September 2023, IMEC aims to forge new trade routes connecting India, the GCC, and Europe. Should it come to fruition, IMEC has the potential to reshape infrastructure, data networks, and economic ties between the East and West, positioning the GCC countries as pivotal gateways for the economic interests of 1.4 billion people in the global south.
Compounded by Saudi Arabia and the UAE’s joining of BRICS as of January 2024, the Middle East's economic influence is set to grow further, adding an additional layer of complexity for investors navigating these shifting global dynamics amid historic debt, slow growth, and political uncertainties in developed economies.
The Middle East's economic and political dynamics play a crucial role in shaping the global investment landscape. The ongoing conflict is not only viewed through the lens of oil prices but also as a potential factor influencing regional and global equity markets. This introduces an additional layer of complexity for investors, prompting a reassessment of risk and return expectations.
For instance, in Qatar, we forecast a strong credit outlook as a result of its liquefied natural gas expansion, strong public finances, robust balance sheet and positive ratings momentum.
A Eurobond of USD 2 billion is set to mature in March 2024, though any potential issuances, if considered, are likely to be opportunistic and may take the form of green bonds to establish a benchmark. This is reflective of the country’s deleveraging priorities.
In the face of these challenges, investors must adopt a nuanced and regionally relevant approach, especially considering the Middle East's unique geopolitical landscape. As these shifts continue, investors must remain vigilant and hedge against potential market disruptions.
At Standard Chartered, we are optimistic about high-quality bonds in developed markets, expecting stable yields due to a low likelihood of further interest rate hikes.
Despite possible equity gains at year-end, the market is anticipated to stay balanced as restrained bond yields and positive earnings contend with a projected economic slowdown.
The overall outlook is uncertain, but the prevailing sentiment favours a positive stance in the bond debate as we approach peak interest rates amid disinflation and global economic challenges.
