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Bond bears taking one step back

30 Apr 2021

Wikus Furstenberg, Refilwe Rakale, Yunus January, Daphne Botha, Aidan Kilian / Interest Rate Team

Economic & bond market review

Global bond market sell-off lost momentum

The spectacular meltdown in global bond market sentiment during February and March lost momentum in April as some calm returned. While the latest data releases continue to point to an economic growth recovery and rising headline inflation, much of this has been widely anticipated and thus priced by markets. Moreover, in the US (the epicentre of the earlier bond market sell-off) the Federal Reserve went the extra mile to ensure that its stance on the timing of future monetary policy tightening is clear: that the withdrawal of accommodation will be a measured process supported by actual data prints; and that it regarded current higher inflation prints as transitionary. This managed to calm earlier market concerns about a repeat of the 2013 taper tantrum episode. That said, we still maintain that current higher levels for the US Treasury yields are appropriate (relative to where we see fair value) and that these yields are likely to drift higher in coming months.

A more constructive global backdrop, sustained rand exchange rate stability, a pullback in excessively bearish local interest rate expectations (as reflected by the Forward Rate Agreement market) and a strong message with a dovish tone by the South African Reserve Bank (SARB) contributed to a return of some sanity. The SARB, unsurprisingly and in contrast to its own mechanistic Quarterly Projection Model (QPM), made it clear that it is in no hurry to tighten monetary policy in light of a fragile economic recovery and the absence of significant demand-pull inflationary pressure. Like many other central banks, the SARB made it clear that it is looking through the widely expected spike in inflation in the near term and will not respond in a knee-jerk fashion.

Inflation is rearing its head, but is largely aligned with expectations

The latest inflation data continued to point to relatively benign underlying inflation, particularly concerning demand-pull forces. In March, the Headline Consumer Inflation Price Index (CPI) accelerated from 2.9% year-on-year a month earlier to 3.2% year-on-year. This acceleration resulted mainly from higher fuel and food prices - as widely expected. In contrast, the year-on-year rate of change for Core CPI nudged lower to 2.5% year-on-year from 2.6% year-on-year in February, an indication of subdued underlying inflationary pressure. As an aside, South Africa’s 2021 maize crop estimate has been revised to the second largest harvest on record, which may help to take the edge off rising food prices in the months ahead.

On the production side, the rate of inflation for final manufactured goods accelerated from 4.0% to 5.2% in March on the back of broad-based price increases. Once again, the bulk of this increase was due to a lift in fuel and food prices. The current significant variance between CPI and PPI rates of change illustrates that the latter tends to be more sensitive to supply price shocks since it comprises only goods prices at the factory gate, with no weight to services. Thus far, this has proved to be very well contained. The point is illustrated in the annual inflation rates for goods and services, being 3.9% year-on-year and 2.6% year-on-year, respectively, as at March 2021. This implies that changes to PPI are not a good forward-looking indicator for price changes at the consumer level.

Figure 1: Breakeven inflation versus actual inflation
The widely expected inflation spike seems largely priced when using this measure

Breakeven inflation versus actual inflation
Source: IRESS, Futuregrowth

Although total private sector credit extension remains weak (falling by 1.5% year-on-year in March), household credit growth has been ticking higher - accelerating by 3.3% year-on-year in March, some way off the recent low of 2.8%. This slow rate of increase is still too weak to lead to strong demand-pull forces and thus helps to convert recent relative price changes into a sustained higher overall rate of inflation.

The current account is going from strength to strength

Developments on the external account continued to deliver positive news. A record merchandise trade surplus of R53 billion in March, together with an upwardly revised R31 billion surplus the previous month, gave rise to a first-quarter surplus of R96.4 billion. This extraordinarily strong performance is still the combined result of strong gains in precious metals and mineral product exports, while merchandise imports increased at a much slower pace. The large merchandise surplus for the first three months of the year bodes well for the current account and, in turn, remains a supportive factor for the rand.   

Figure 2: Changes to the South African current account balance
Largest merchandise surplus in decades

Changes to the South African current account balance
Source: Bloomberg, Futuregrowth

Fiscal data is slowly moving in the right direction

Main budget data for March (the last month of fiscal 2020/21) pointed in the direction of a smaller full-year budget deficit than forecast by National Treasury in the February budget. While the bulk of the improvement is due to a significant R38billion of additional tax revenue collection for the full year, lower total expenditure also contributed positively. As a result, our latest estimates point to a consolidated budget deficit of 12.8% of GDP compared to the official February budget estimate of 14.0%. While the improvement is welcomed, execution risks related to the lowering of the public sector wage bill remain very high, especially with wage negotiations having hit a deadlock. Even so, the latest developments are expected to give South Africa a breather in near-term international rating agency action. 

Nominal bond market returns surpassed those of inflation-linked bonds and
cash during April

In stark contrast to the first quarter of this year, the developments described above led to improved investor sentiment and lower bond yields. As a result, the FTSE JSE All Bond Index (ALBI) rendered a return of 1.90%, with the biggest positive contribution of 2.09% and 2.28% from bonds in the 7- to 12-year and 12+ year maturity bands, respectively.

Inflation-linked bond yields continued to drift lower, owing to sustained inflation-hedging demand. As a result, the FTSE JSE Government Inflation-linked Index (IGOV) rendered a return of 1.14%, slightly lower than that of the ALBI. The combination of reasonable valuation and expectations of higher inflation in the near term (which will boost the inflation carry offered by these bonds) served as catalysts for sustained interest in this asset class. The performances rendered by both nominal and inflation-linked bonds were well above the 0.28% offered by cash during this period.

Figure 3: Bond market returns (periods ending 30 April 2021)

Bond market returns (periods ending 30 April 2021)
Source: JSE, Futuregrowth


The sharp increase in yields in some of the major global bond markets (particularly the US) were backed by improved economic growth prospects, fears of higher inflation, and, by implication, future monetary policy tightening experienced in the first quarter. This lost momentum in April as these fears were played down by policymakers, especially the Federal Reserve. Locally, extremely bearish rate expectations were also tempered by a strong message by the SARB, insisting that it regards upcoming inflation spikes as transitory - with no immediate impact on its policy rate. On the fiscal front, March data points to a lower budget deficit compared to the official estimates released in February. All of the above contributed to a reprieve in bearish bond market sentiment, allowing both nominal and inflation-linked bond returns to outperform cash by a significant margin in April.


Key economic indicators and forecasts (annual averages)


    2017 2018 2019 2020 2021 2022
Gobal GDP   3.4% 3.3% 2.6% -3.6% 6.6% 4.5%
SA GDP   1.4% 0.8% 0.4% -7.0% 5.0% 2.0%
SA Headline CPI   5.3% 4.6% 4.1% 3.3% 4.0% 4.5%
SA Current Account (% of GDP)   -2.5% -3.5% -3.2% 2.2% 1.7% -0.5%

Source: Old Mutual Investment Group