This article was originally published in the Finweek newsletter.
Investors are eyeing government bonds with maturities in the middle of the bond curve as prices dropped and yields spiked recently. This poses an attractive proposition amid the South African Reserve Bank’s (Sarb’s) low inflation expectations for the rest of the year.
“The yield on the R186 bond is now at 9.5% and longer-dated government bonds are offering attractive yields of 11.5%,” Bronwyn Blood, a fund manager at Granate Asset Management, tells finweek. “If one considers the latest forecasts of inflation from the Sarb at 3.5% to 4%, this means government bonds are offering very attractive above-inflation returns of 5.5% to 7.5%, which is extremely attractive if you consider government bonds as the most ‘risk-free’ investment in our economy.”
At these levels, Granate has been buyers of bonds, Blood says.
After the central bank’s 1 percentage point cut in the repo rate on 13 April – which followed on a similar cut in March – the market is now expecting a further reduction in the policy lending rate.
“We are at this stage expecting more cuts and the market is expecting another 1 percentage point reduction in the repo rate,” she says.
Given the steep decline in the oil price – where SA imports about 70% of its oil needs – and a dearth of demand for the next six to 12 months, the Sarb forecasts headline consumer price inflation to reach 3.6% this year and 4.5% next year. Core inflation is estimated at an average 3.8% this year and 4% for next year. The bank targets an inflation band of between 3% and 6%.
The bank went all out to ensure enough liquidity in the market. It extended the repo facility in the money market – which would enable banks to purchase more bonds – and opened channels to purchase bonds itself in the secondary market, explains Blood. By relaxing the Basel III liquidity and capital requirements for the banking sector, the Sarb enabled banks to extend support to struggling corporates and small- and medium-enterprises, she explains. This is evident in the payment holidays that many of the four large banks extended to their corporate customers.
Across the world, the monetary stimulus (or support from central banks) totals about $8tr, Hannes van den Berg, fund manager at Ninety One (formerly Investec Asset Management) told financial advisers in a webinar on 16 April.
“It is not a liquidity crisis; markets are functioning,” he said in reference to the 2008 global financial crisis where a sudden dearth in liquidity – especially among banks – led to a long and lingering recession in many markets.
“What is different from 2008 is the size of the stimulus and the speed at which it was announced,” he said.
Even as the whole yield curve may pose value, Wikus Furstenberg, head of interest rates at Futuregrowth, seems wary of the longer-dated bonds.
“I am worried about the long side of the curve,” he told finweek. “Yields are high at the back end, which shows there are structural problems. And Covid-19 makes it even more uncertain.”
These structural problems refer to the difficult situation that National Treasury finds itself in with an expected fiscal deficit of more than 7% of GDP by the end of this book year. The government announced a mild fiscal stimulus package, but is also expected to receive a far smaller amount of corporate and personal income taxes as business are closed and people loose their jobs.
The worrying state of government’s finances led to Moody’s Investors Service dropping SA’s last investment-grade rating for its sovereign bonds last month. Fitch followed and now rates SA’s debt two notches below investment grade.
The drop to junk forced SA’s government bonds out of the World Government Bond Index (WGBI), which tracks investment-grade government debt. Many investment funds are either passively following the index, or active fund managers are mandated to allocate a fixed percentage of money to investment-grade debt. These funds would finally have left SA at the end of April when the country drops from the index.
That leaves active fund managers from abroad to invest in rand-denominated government debt. This poses its own problem.
“The cushion of passive asset managers which existed since 2012 (when SA joined the index) will now be gone,” explains Furstenberg. “We can expect increased volatility in the bond market after SA exits the WGBI and only active managers are left.
”He expects the most volatility to be on the long side of the yield curve – those bonds with longer maturities. With the steepening of the yield curve – or rather yields on longer-dated bonds increasing – Furstenberg warns of a so-called “bearish yield curve steepening” where longer-dated bonds are sold off (hence the price drops and the yield rises). Add that to the expected volatility following the exit of passive funds from these bonds and he warns of a possible “whiplash on the long side” of the curve.
In the meantime, Furstenberg says they are looking in the space of bonds with a maturity of 6 to 15 years out. “The R186 looks very attractive,” he says of the ten-year benchmark bond. “That, however, predicts nothing of what is going to happen in future.”
This article was written exclusively for finweek’s 17 April newsletter. You can subscribe to the newsletter here: http://bit.ly/finweeknews