Average yields for Islamic bonds on the HSBC/Nasdaq Dubai UAE US dollar sukuk index rose 40.8 basis points and closed higher still at 4.48 per cent on Friday, the highest level since January last year. Funds tracking the index are now making losses, with total returns on the index down 1.4 per cent year-to-date.
The sell-off of US treasuries, which pushed 10-year yields to 2.52 per cent on Friday, has "really spooked investors" and the possibility of a rise to 3 per cent was creating a "panic", said Gary Dugan, the chief investment officer for the Middle East and Asia at Coutts, the private bank.
"Investors knew they had too many bonds and sukuks but thought they had time to get out but the markets have moved too fast for them," he said.
"The GCC Islamic markets had been relatively unscathed up to that point because holders were in the main local GCC investors …There are some Islamic banks that we believe haven't liquidated yet so the selling pressure might persist."
Coutts had previously warned of signs of a bubble emerging in emerging market and Islamic debt.
Since Thursday, Islamic debt has performed little better than conventional bonds that had been faring worse during the recent bout of volatility.
Bond yields rose by 42.1 basis points to 4.28 per cent. Total returns of UAE conventional bonds tracked by the HSBC/Nasdaq Dubai index are nevertheless down 3.1 per cent this year.
The rout on fixed-income markets began last month when investors started to worry that the US Federal Reserve was planning to start to taper its US$85 billion a month purchases of bonds and mortgage securities, signalling an end to the crisis-era policy of quantitative easing.
The programme, which has swelled the size of the Fed's balance sheet to $3.3 trillion as it pumped liquidity into the US economy through bond purchases, averted a collapse of the global financial system in the short-term but has left significant concerns about the central bank's exit strategy.The latest speech on Wednesday night had done little to calm investor nerves, analysts from National Bank of Kuwait wrote in a research report.
"The chairman of the Fed, Ben Bernanke, tried to provide some comfort to the bond market but the hope lasted only seconds into his speech," the report said. "Investors took these signs as the Fed could be preparing for tapering in the second part of the year but Bernanke tried to limit the impact by suggesting tapering would not be over until mid-2014."
The end of quantitative easing is expected to have a disproportionate impact on riskier UAE fixed income, especially in Dubai, analysts from Bank of America Merrill Lynch wrote in a research report last week.
"Potential gradual normalisation of regional real rates should have a largely muted impact on Mena macro, though less favourable global liquidity conditions or EM risk appetite would mean greater scrutiny of credit risk in the Dubai Inc space," the report said.
Dubai World and Dubai Group have both recently conducted successful asset sales, with the completion of Dubai Group's long-running debt restructuring said to be "imminent", according to people close to the firm, after it sold a consumer finance unit to First Gulf Bank, Abu Dhabi's second-largest lender by market capitalisation.