How the war between Israel and Hamas develops and whether or not it draws in more of the region’s states will determine the conflict’s impact on credit markets.
The immediate effect was a relatively indiscriminate sell-off in Middle East paper, now largely unwound. Regional borrowers, meanwhile, should be able to access the primary markets, though investors may now demand bigger concessions.
The near to medium-term consequences of the war for bond investors should be limited, said investors. “Israel will likely try and reassess its security arrangements, which will likely have direct consequences for how the Gaza Strip and the West Bank are governed and its economic ties, but I don‘t expect this to impact other relationships in the Middle East,” said Philip Fielding, co-head of emerging market debt at fund manager MacKay Shields.
“Of late, we have seen a substantial thaw in diplomatic relations with the United Arab Emirates and even Saudi Arabia, and early indications point to a desire to maintain this progress.”
When markets opened on Monday, following the war’s outbreak over the weekend, the price of Israel’s debt quickly dropped, losing around 2.5– 4.5 points.
Traders said that they were also seeing other Middle East credits getting marked down, especially neighbouring high-yield sovereigns such as Egypt, Jordan and Lebanon. But prices have subsequently recovered, as much because of a rally in rates since the start of the week as anything specifically related to the war.
For example, Jordan's US$1bn 7.375% October 2047s are now marked at 77.68 bid, according to LSEG data, not far from where they closed on Friday, having initially fallen almost two points.
Israel’s debt is still quoted lower, but traders reported seeing buying activity as prices fell and by Tuesday the bonds had made back some of the losses. The sovereign’s US$2bn 4.5% January 2033s are still down 1.3 points since last Friday but are up a point from Monday’s lows to 90.56.
Escalation impact
The bigger risk to financial markets would be if the conflict takes unexpected turns, exposing investors at either end of the region's credit spectrum.
“I am concerned that our risks have become more fat-tailed,” said Scott Fleming, global emerging markets portfolio manager at Fideuram Asset Management. “In that scenario, I would have deeper concerns about the weaker names with much weaker balance sheets, like Egypt and Jordan. I would also be concerned about flight-to-quality risks.”
On the other hand, better-rated names in the region – Saudi Arabian or Emirati borrowers, for example – are already trading at very tight spreads. “I don’t believe these valuations currently compensate you for what is clearly now elevated geopolitical risk in that region,” Fleming said.
A key second-order effect on financial markets, and with bigger global consequences, would be through oil prices. Iran, for example, has this year increased its production of oil significantly. If, as a consequence of its support for Hamas, Tehran incurs further sanctions, oil prices could experience upward pressure.
“We’ll likely see some persistent risk premium on oil prices if this leads to longer-term concern about an Israel-Iran standoff,” said Kaan Nazli, senior economist and portfolio manager at Neuberger Berman. “This would benefit Middle Eastern oil exporters in general but hurt the high-yield universe, as it will add to the higher-for-longer theme, making market access much more complicated for these issuers.”
Primary pressure
No Middle Eastern borrower has yet to discover the cost of accessing the primary market in the immediate aftermath of the conflict, although syndicate bankers suspect that a premium might be required, even for high-quality issuers far removed from the conflict.
One such name currently in the pipeline is Oman Telecommunications, which last week met with investors to discuss the issue of a US dollar benchmark seven-year 144A/Reg S sukuk offering.
“Some of the guys in the GCC – even though it’s not directly related to them, and they definitely do have market access – would they have to pay a premium, just because they get labelled as Middle East? Possibly,” said one banker.
The sukuk market has been particularly supportive of new issues this year, with a strong local bid allowing issuers to raise funding at particularly tight levels. Given this regional support for the asset class, it could be better insulated against any wider caution around Middle East names.
“A big part of the buyer base is the Islamic accounts,” the banker said. “I cannot imagine that their investment decisions have changed materially yet based on what is happening in Israel.”
This should be helpful for Omantel, which is looking to issue its first deal in the format. “But an issuer like Omantel is particularly price sensitive,” said one credit trader. “Omani names typically trade tight to the sovereign and are very aware of that fact.”
Omantel is 80% government owned and carries Ba2 (positive) and BB+ (stable) ratings from Moody’s and Fitch.