Debt: Is Middle East deficit to continue to grow?

There’s a burgeoning opportunity in Middle East debt markets, according to Bloomberg.

Abdul Kadir Hussain, a Dubai-based fund manager who weathered the emirate’s near default almost 10 years ago, has been plotting the average credit risk of emerging-market bonds against the extra yield investors demand to hold debt in the Arab world.

The two have been converging, which means the potential reward for holding riskier developing-nation bonds has almost vanished when compared with Middle Eastern debt, said Hussain, the head of fixed income at Arqaam Capital Ltd.

“The spreads in the Mideast and the underlying credit quality gives you a cushion when the bond bubble finally bursts, because they didn’t rally as much as the rest of the world,” he said. “We’re reducing our risk profile globally, but within the region, we’re looking at lower-rated names, such as companies in Dubai, and sovereign debt in Egypt and Bahrain.”

While stimulus in the developed world fuels demand for high-yielding assets, investors overlooked debt in the Arab world because of tight spreads and a diplomatic spat among the region’s most powerful countries. A group of Saudi Arabia-led nations have cut ties with Qatar, accusing the Gulf state of supporting terrorist groups. Wednesday marks 100 days since the crisis began.

Higher Grade

The five-year benchmark of credit-default swaps for emerging markets has narrowed about 70 basis points this year to 175 on Tuesday, according to the Markit CDX Emerging Markets Index. The extra yield for holding Middle Eastern bonds climbed four basis points to 170, a JPMorgan Chase & Co. gauge shows. That five basis-point-difference is the tightest spread in more than 10 years.

Read More: Decade-Low Credit Risk Shows Emerging-Market Optimism Intact

Of the emerging-market bonds assessed by S&P Global Ratings, a third have credit ratings of A- and higher compared with half in the Arab world, according to data compiled by Bloomberg. The Middle East is home to about 50 percent of the world’s proven oil reserves.

“This risk-loving frenzy is ignoring all the noise in the background,” Hussain said, who explained that he compared emerging credit risk with Middle East bond spreads because CDS contracts in the Arab world are relatively illiquid.

Emerging-market bond spreads are so tight that if the “noise comes to fruition, be it turmoil in Asia or risks associated with U.S. fiscal policy, investors are completely exposed to a correction,” he said.

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