The favourable oil market dynamics and GCC macro-outlook is supportive of GCC Sukuks in the medium term, according to an outlook briefing on the Sukuk asset class by Azimut, one of the largest independent asset management companies in Europe and the manager of the largest sukuk fund in the world.
The asset manager said issuer fundamentals should continue to strengthen on the back of improved economic, fiscal and external prospects.
"Middle East fixed income should also benefit from positive technical as global investors will look to be overweight the region based on the region's favourable macro-economic dynamics as illustrated by elevated fiscal and current account balances.
"Ample regional liquidity should be another source of support for GCC Sukuks as local investors will look to deploy surplus cash in local financial products. In our view, high absolute yields on fixed income Sukuks makes the asset class more attractive for investors than in previous years.
The briefing note continued: "The cyclical peak in US yields is likely behind us, given the macro backdrop of likely slowdown in US growth and peak core inflation. Despite favourable inflation data, we don't expect a sharp decline in long-dated yields due to the increase in bond supply and the reduction in central bank QE, which should cause a material shift in the supply/demand equation and will likely drive up global term premia."
"Given the inverted yield curve, we prefer the short end as we expect the long end to be volatile as the ECB likely continues to hike rates and inflation will continue to pick up, due to the reopening of China."
Within the credit spectrum, Azimut said it preferred high yield over investment grade as investment grade bonds trade at fair value.
"We are comfortable with adding to high yield exposure as the fundamentals of GCC corporate and sovereign issuers should continue to improve, albeit at a more moderate pace compared to 2022.
"We expect continued deleveraging in 2023 driven by elevated commodity prices and a favourable business environment. We expect corporates to have access to multiple refinancing channels as GCC banks' fundamentals are sound, with banks reporting healthy liquidity and capital ratios."
In terms of country allocation, Azimut said it preferred to be overweight on the UAE, specifically Dubai, which benefits from higher oil prices and tourism and real estate recovery as well as from a positive fallout from the Russia/Ukraine conflict.
"We expect limited issuance from Dubai sovereign and quasi-sovereign entities, which should be supportive for existing bonds. We also find value in UAE GREs which trade cheap given their strong stand-alone fundamentals and sovereign support.
"We also stay cautious on Turkey despite recent outperformance of Turkish bonds. Turkey's policy rate cuts in the face of elevated inflation poses long-term threat to the country's economic stability, in addition to damaging the country's reputation with foreign investors.
"However, light positioning in the Turkey complex has resulted in a much better performance in USD debt than the policy action would suggest. Given the unconventional monetary policy and uncertainty surrounding upcoming elections, we therefore prefer to be underweight on Turkish debt until we get more clarity on the impact on Turkish economy from the unconventional policies and uncertain political outcome."
As for the GCC economic outlook, Azimut said the removal of COVID restrictions and the rise in oil prices as well in oil production boosted economic growth for the GCC region in 2022.
"While we expect growth to remain healthy in 2023, moderation is likely as OPEC oil production increases are reversed. The GCC stands out among emerging markets peers for its very low funding needs and among global peers for favourable growth and inflation outlook.
"Despite diversification efforts, oil revenues remain vital to GCC economies accounting for the bulk of government revenues and exports.
"We believe oil will continue to trade at much higher levels than previous years due to proactive management of supply/demand balance by OPEC+ countries. Second, we believe an increase in US shale production remains unlikely in the medium term, due to a number of financial, regulatory and supply-related constraints."
