Mideast wealth funds fret over US Treasuries

Sovereign wealth funds in the Middle East are growing increasingly concerned about the health of the US Treasury market, raising questions about whether they will remain such active buyers of US government debt.

Middle Eastern buyers are the fifth-largest investors in Treasuries after China, Japan, the UK and Caribbean banking centres, and their appetite could prove critical to US government plans to issue mountains of debt to fund stimulus efforts.
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So far there is little sign of a flight from the dollar or from Treasuries, but senior executives at several sovereign funds in the region say the US Treasury has been conducting a dialogue to reassure Middle Eastern investors that US government debt still offers value.

Treasury prices soared – and Treasury yields declined – last year as investors sought the safety of government debt. Yields have started rising this year, and Middle East investors remain concerned that they will continue to do so, reducing the value of holdings and removing the incentive to buy more.

Current Treasury yields were an expression of “the psychology of fear”, said the head of one sovereign fund in the Middle East. “It is the financial equivalent of a 10-alarm fire outside one’s home.”

Adding to the skittishness of Middle East investors is the fear that the dollar will also decline, further depressing the value of US debt holdings. Since oil is priced in dollars, these investors are inclined to invest in dollar-denominated assets.

“If there is a further meltdown in the financial system, it could have an impact on the dollar,” says one Gulf central bank governor. “A run on the dollar would be the worst-case scenario.”

Deutsche Bank estimates that Treasury issuance will rise sharply as a result of the stimulus efforts – “with at least $2,000bn [€1,538bn, £1,388bn] in net marketable borrowing likely to occur this year and potentially that much again next year”.

Middle Eastern investors will also face competing claims at home, and will probably have to scale back Treasury purchases, at least at the margin, as they allocate funds to help revive their domestic economies.

“There are supply issues, valuation issues and demand issues with existing holders,” says Mohamed El-Erian, chief executive at Pimco, the US-based bond investor.

“Where you go from here is a big dilemma.