Following Iran’s retaliatory attack on Israel on April 13, markets now await Israel’s promised response which could worsen this unprecedented “direct war” and possibly prompt a broader conflict in the Middle East.

Thus far, investors with exposure to our covered Middle East bonds such as Kingdom of Saudi Arabia (KSA), Oman (OMAN) and Bahrain (BHRAIN), will be pleased to know that markets have not really panicked. Our trading desk notes that the short-term bonds have even seen some opportunistic demand.

While the recent flight to safety has hammered some risk assets, including the aforementioned sovereign bonds, we note that it’s the renewed prospect of delayed US Fed rate cuts that has mostly driven the latest round of sell-offs.

The Fed’s “pivot on a pivot”, warranted by still-sticky US inflation, has prompted markets to price out Fed rate cuts until the third quarter, sending US yields to new highs this year. Fed funds futures reflect that markets now price-in less than two rate cuts this year — a significant reduction from the previous expectations of six rate cuts back in December, when the US central bank first softened its stance on staying restrictive.

Do we expect further losses?

Despite the remaining uncertainties in the Middle East, we note that the sovereign issuers’ fundamentals (e.g., external balances in surplus, well-supported current accounts, favorable terms of trade, falling debt) will continue to keep their bond prices supported.

We therefore expect that the selling pressure on the Gulf Cooperation Council (GCC) countries, particularly KSA, Oman, Bahrain, and Qatar, will be contained in the coming weeks.

Our independent credits research partner, CreditSights, sees that high-yield (HY) emerging market (EM) bonds are more at risk of a global repricing than investment grade (IG) bonds. However, CreditSights notes that Oman’s fundamentals have “considerably improved” and is therefore unlikely to be affected. The country’s political neutrality should also make it an unlikely target in further retaliations. Bahrain will also continue to benefit from its legally binding security pact with the US.

KSA, Oman, and Bahrain have all pressed Israel to show restraint and it’s clear that the neighboring countries do not want to get involved in an all-out war. Israel has assured its Arab neighbors that it will not threaten their security in its prospective response. In our view, further escalation will also be tempered by the risk of tougher sanctions on Iran from the West.

Is this a good buying opportunity?

We believe Saudi Arabia and Oman may appear attractive to investors as the two countries stand to benefit from elevated energy prices, which have recently been boosted by the geopolitical tensions and high demand for oil.

CreditSights notes that Omani bonds have become quite defensive and less exposed to movements in US Treasuries than most EM bonds, while KSA bonds are relatively cheap at current levels.

However, our Global Credits Trading team issued this caveat: “While we’re not too worried about the names we cover for the Middle East, we are cautious about adding too much exposure given the risk of further escalation. The uptick in oil prices should generally be a tailwind for these names as long as tensions de-escalate.”

Given the current risk backdrop and a possible pullback of Fed rate cut expectations, our credits trading team favors short-term investment grade bonds, specifically in the 2-year to 5-year tenor buckets.

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PATTY MEMBREBE is a Financial Markets Analyst at Metrobank – Institutional Investors Coverage Division, under the Market Strategy and Advisory Section. She communicates strategies on fixed income, rates, and portfolio solutions for our high-net-worth individual and institutional clients. She holds a Master’s Degree in Economics from Ateneo de Manila University. In her free time, she enjoys watching indie films and attending gigs to support local indie music.