The Saudis Can't Just Throw Their Bond Market Weight Around

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(Bloomberg Gadfly) -- Saudi Arabia could return to the international bond market this month for a third time, once it has wrapped up refinancing a syndicated loan. The kingdom's last two jumbo issues went well, but this time is different.

The Federal Reserve will most likely raises rates at its March 20-21 meeting, and funding costs are rising along with U.S. Treasury yields. Credit spreads are widening also, notably in the shorter maturities for Saudi debt.

Oman looks smart to have jumped the gun with $6.5 billion of bonds in January. The other members of the Gulf Cooperation Council will likely be close behind the Saudis in order to get ahead of their funding needs for the year.

The Saudis have a first-world problem -- they have to pick their maturity of issuance. If they're smart, they'll be careful to avoid skewing their repayment profile to any one year. That could cause refunding stress in the future. Building a smooth yield curve allows the kingdom to issue at will when markets are favorable. 

There should be decent demand. Any of its bonds will go straight into the major bond indexes and investors are still largely underweight what is still a relatively rare issuer, for the size of its economy. 

But a rising bond and credit spread market can be treacherous even for the largest of issuers, so the Saudis shouldn't take their potential buyers for granted. Though investors getting ready for the deal would do well to mind the Saudi gaps, the Saudis would do well to pay heed to what investors want. 

Long-dated maturities are a natural fit for the issuer, given its funding requirements for its Vision 2030 goals for its economy. But this is a tricky affair. True, a 20-year bond should go pretty well, not least since Nigeria's recent success with this highlights investor demand in this area.

A 30-year would be a more-standard approach, but it just did one in September. This comes due in 2047, so offering another one for 2048 would be such a clear-cut case of yield curve lumpiness that investors would be right to laugh in their face. Though a hefty coupon, of at least 5 percent, would help them get over themselves.

A reopening of one of its recent issues might not go down too badly. They all now match current maturities of the equivalent U.S. Treasury benchmarks. At at $3 billion the 2.875 percent issue due in March 2023 is relatively small and its maturity is spot on five years.

It may also find demand to fill a gap in its fledgling yield curve at seven years -- this matches a benchmark part of the U.S. Treasury yield curve, so investors would have an easy time hedging their Saudi purchase. While a proper yield curve could do with a six-year or 11-year, these are awkward for buyers to hedge against so this route would also likely have to involve a chunky new issue premium. 

And that is the nub of how Saudi should approach its issuing program, looking at different sources and maturities to avoid overloading one part of the curve. Flexibility is all in keeping the investor base happy, and this should be the kingdom's biggest concern -- as it will be coming back to the market regularly.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Gadfly columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

©2018 Bloomberg L.P.

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