US rate cuts open window for GCC bond market gains

It is now all but certain that the Federal Reserve will cut the US overnight borrowing rate, currently 4.25 percent, by at least 25 basis points at its September 18 Federal Open Market Committee (FOMC) meeting. The labour market is losing momentum, while tariff-driven inflation has yet to show up in the Consumer Price Index.

The Trump White House has ramped up pressure on Fed Chair Jerome Powell to deliver a fresh round of rate cuts. Treasury secretary Scott Bessent has publicly urged a 150-175 basis-point reduction in the Fed funds rate to jumpstart US growth. If the FOMC yields, the policy rate could sink to 2.5 percent by next summer.

Such a move would sharply reduce the interest income earned by GCC family offices and corporates on three-month US dollar bank deposits, which now yield around 4 percent or less in the Gulf.

Savers and investors in the region will therefore need to consider reallocating from cash holdings into bond and sukuk strategies within the GCC market.

Credit risk, duration risk and interest rate risk are unavoidable when investing in the GCC bond market, which is predominantly denominated in US dollars.

The kingdom of Bahrain sovereign bond has a coupon of 6.75 percent and a maturity date of August 20, 2029. Bahrain may be well into non-investment grade territory but, based on guarantees or attachment of specific cash flows, Fitch assigns this issue of Bahrain debt a BBB credit rating, which is investment grade. The four-year bond offers a yield to maturity of 5.65 percent.

If the Fed funds rate drops to 2.5 percent in the next easing cycle, the yield to maturity on Bahrain’s bonds may also decline, allowing investors to book capital gains.

Investors in the UAE can also buy bonds and sukuk issued by prime Emirati banks which are majority-owned by the governments of Abu Dhabi and Dubai.

For instance, First Abu Dhabi Bank (FAB) has a subordinated debt issue which offers a 6.32 percent coupon and a maturity date of April 04, 2034.

This FAB bond is trading at 104 and provides a yield to maturity of 5 percent. FAB has the lowest funding cost in the UAE, with an S&P rating of AA-.

Investors seeking Dubai bank exposure may look to Emirates NBD, the city’s largest universal bank. Its perpetual bond carries a 6.25 percent coupon, is trading at 103, and has a next call date of August 25, 2030, translating into a yield to call of 5.65 percent.

Suppose the Federal Reserve cuts its benchmark interest rate at every FOMC meeting after September, as Wall Street and the US Treasury secretary now expect. In that case, bond market yields will also fall, and the price of GCC sovereign and bank debt will rise.

Regional investors should not wait for the Fed funds rate to bottom at 2.5 percent in the coming easing cycle. By then, GCC bond prices will likely have already risen sharply, as cash yields compress in response to the Fed’s dovish pivot.

While it is prudent for every investor to retain a cash cushion to cover unexpected emergencies, the Wall Street dictum that “cash is trash” is most relevant when the Fed slashes its policy rate.

Although bonds typically offer higher yields than bank deposits, investors remain exposed to risks. A downgrade in an issuer’s credit rating or a rise in interest rates, driven by inflation or shock events such as a sudden war or oil price spike, as seen after Saddam Hussein’s invasion of Kuwait or Russia’s invasion of Ukraine, can trigger losses.

The biggest risk to intermediate-term bonds issued by GCC banks and governments is the supply glut in the oil market and a plunge in Brent crude below its current $66 spot price