The BLOM Bond Index (BBI), which tracks Lebanese government Eurobonds (excluding coupon payments), rose by 6.82% this week to 9.72 points. This increase is largely due to investor optimism surrounding the recent ceasefire between Lebanon and Israel, which has led to speculation about potential improvements in the country’s economic and financial situation. As hopes for a permanent end to the war grow, investors are betting that this stability could lead to needed reforms and possibly an agreement with the International Monetary Fund (IMF) to help lift Lebanon out of default.
Oussama Nasr, a former derivatives banker, analyzed the Lebanese sovereign dollar bonds rally in the Financial Times’ “What should Lebanon’s Eurobonds be worth?” (October 28, 2024). He explained that the bonds’ price reflects two possible outcomes:
The recent increase in bond prices suggests that the probability of the bonds being worth $0 is 51.4%, while the probability of being worth $0.20 is 48.6% (0.514*0+0.486*0.2=0.0972)
Nasr also used options theory to explain the bond price surge. The value of an option increases with higher volatility, especially for out-of-the-money options (those with no current value). We explained these concepts in depth in a previous article titled Analyzing Lebanon’s Eurobonds Amid War.
However, the Bond Index’s increase slowed on Friday after accusations that both Israel and Lebanon breached the ceasefire agreement, despite the fact that the Speaker of Parliament announced that on January 9th, 2025, the chamber will elect a new Lebanese President.
The Lebanese Army reported on X that Israel violated Lebanon’s airspace and targeted its territory with various weapons. In fact, Israel conducted airstrikes near Baysariyah, north of the Litani River. While the deal requires dismantling Hezbollah facilities south of the Litani River, it does not mention facilities to the north.
Additionally, the ceasefire agreement requires both Hezbollah and Israeli forces to withdraw gradually from southern Lebanon, allowing for the deployment of Lebanese troops and UN peacekeepers. Israeli forces are still present in some southern Lebanese villages and have until the end of the 60-day period to leave. Therefore, Israel has warned Lebanese citizens against returning to these villages. On Thursday, Israel opened fire on what it called “suspects” in vehicles arriving at several areas in the southern zone, claiming it was a breach of the truce.
While the ceasefire aims to be permanent, these violations threaten its stability, making the temporary truce fragile and possibly short-lived.
When bond prices go up, yields go down. Consequently, the yield on 5-year bonds dropped by 430 basis points to 125.5%, and the yield on 10-year bonds fell by 410 basis points to 93% this week.
Similarly, in the U.S., the yield curve declined as treasury yields fell this week by 5, 19, and 18 basis points, reaching 4.34%, 4.11%, and 4.25%, respectively, on November 28, 2024.
This decline was driven by the nomination of Scott Bessent as US Treasury Secretary, which eased worries of Trump’s effect on the Federal Reserve’s interest rate path. The fall accelerated after the October personal consumption expenditures price index, Fed’s favorite inflation gauge, increased to 2.3% yearly from 2.1% in September, in line with the Dow Jones consensus forecast, signaling minor change in the Fed’s stance on rate cuts.
Amid these developments, traders are now pricing in a 66.5% chance of a quarter-point rate cut at the Federal Reserve’s December meeting, while the likelihood of no change is 33.5%, according to the CME Group’s FedWatch tool.
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