The impact of Brexit has rattled the markets with US$2.08tn having been wiped from global equities the day the result of the vote was announced, according to Standard & Poor’s Dow Jones Indices.
Europe was, as expected, hit particularly heavily. The Polish zloty fell from 3.8345 against the US dollar on the eve of the referendum to its present 4.0645 against the dollar, according to Bloomberg.
Even many EMs outside of the continent, especially those in Africa and Latin America, have seen their currencies suffer as a result of the vote. Figures from Bloomberg showed the South African rand fell from 14.4161 against the dollar on June 23 to its current 15.3253 versus the greenback.
Not all EM regions have felt negative shockwaves from the referendum’s result. Although Asia remained relatively unaffected, the Middle East appears to have actually benefitted from the global flight to safety.
According to Emirates NBD’s GCC credit weekly report, the global risk-off from Brexit caused 2 and 10-year US Treasury yields to close at 0.63% and 1.56% respectively, a respective drop of 15 and 18bp.
US government 10-year bond yields fell from 1.7458 on June 23 to their present 1.4698 according to Bloomberg.
“When there is a risk aversion, benchmark yields fall. 10-year US Treasury yields are down 25bp which is a positive boost for GCC bonds. Overall Brexit has not been too bad a risk for GCC bonds,” said Anita Yadav, Head of Fixed Income Research at Emirates NBD.
Regardless of the impact of Brexit, the GCC’s credit markets have remained remarkably resilient throughout the global low growth environment.
Credit spreads have been widening due to low growth, which has affected high yield markets. In the GCC, only 8% of the markets are high yield, whilst over two thirds of the region’s markets are high grade.
Yadav noted that the widening of credit spreads was less across the GCC than in European high yield assets. In the GCC spreads have widened by 18bp, compared to the 42bp widening in European high yield.
“Credit spreads here react more to oil, which has been performing relatively well,” she stated. “The GCC is based on petro-economies.”
Even oil has felt the impact of the Brexit fallout, which according to the report fell about 5% on June 24, with Brent crude closing at US$48.41 per barrel. On a quarterly basis it is still 20% higher than previously. Brent crude is currently trading at US$47.94 per barrel according to Bloomberg.
Accordingly, lower oil prices have widened GCC spreads. The report noted that the average spread on GCC bonds widened by 18bp to 294bp.
However with oil likely to hover between US$45 and US$55 per barrel, credit spreads will be unlikely to widen further, therefore supporting GCC bonds. As well as benefitting from relatively steady oil prices, increased foreign demand for the region’s debt has offset the negative effects of high leverage.
There has been an increasing amount of international participation from foreign lenders in the GCC bond markets this year, and US$29bn has already been issued in the first half of 2016. This is in comparison to the US$20bn of total issuance to emerge in 2015.
“New issuances are credit negative, but because there are so many negative rates and low yields across the rest of world, money is still coming in,” Yadav said.
She added that despite new supply, spreads were not widening significantly.
“Large supply is counterbalanced by demand from international investors with access to cheap liquidity.”
Although GCC spreads seem unlikely to widen, defaults can break the trend. An increase in NPLs is likely across the banking sector, but as roughly 85% of the sector is linked to government, risk of defaults remains low, particularly because the GCC is a very capital rich region. This means that the relative value of GCC debt is higher than that of its EM counterparts.
“GCC bonds are looking attractive compared to other regions,” Yadav said. “When spreads globally begin to tighten, those of the GCC will tighten faster than those of other regions.”