A sell-off in SA bonds that has pushed up benchmark yields by 78 basis points since the start of the year makes them an even more compelling investment despite ongoing concerns about worldwide inflation amid a flood of global monetary and fiscal stimulus in response to the Covid-19 pandemic.
That is the view of Momentum Investments’s head of fixed income, Ian Scott, who says the spike in SA yields makes local government bonds “cheap”, rendering them a better investment than low-risk money market instruments or cash. Momentum Investments oversaw about R260bn in assets as at March 31.
Bond yields are a measure of how much an investor receives from a fixed-income security in the form of the coupon it pays, relative to the market price paid for it at the time of purchase. A lower market price therefore results in a higher yield, given that coupons on nominal bonds are constant.
“SA bonds are cheap,” Scott said in an interview with Business Day. “We still like SA bonds but there will be volatility, so you shouldn’t buy into local bonds if you’re looking for a short-term punt — you need to take a longer-term view.”
The yield on SA’s benchmark R2030 bond has risen 78 basis points since the start of the year as global bonds plunged in the first quarter of 2021 amid a so-called “reflation trade” that saw investors pricing in a rapid worldwide economic recovery from the pandemic. The widespread anticipation of a stronger-than-expected economic recovery was largely driven by the unprecedented monetary and fiscal stimulus from governments worldwide, resulting in US treasury yields rising steadily in the first three months of the year.
Rising treasury yields began to affect demand for emerging-market debt, particularly in late February and March, as investors began pricing in the prospect of higher US interest rates and consequent better dollar-denominated returns. In SA that selling impetus was worsened by concerns about the government’s debt trajectory with Moody’s Investors Service and Fitch Ratings questioning SA’s ability to achieve its goal of stabilising debt at 88.9% of GDP by 2025/2026.
Reduce expenditure
So far foreign investors have dumped R27.2bn of SA bonds in 2021, a trend that could accelerate if the government fails to rein in its burgeoning debt.
“A lot depends on whether [the] government can hold the line on spending,” said Scott. “[The] government can’t do much more to collect more tax, so what we need is to reduce government expenditure. But whether that’s possible in an election year still remains the big question.”
Still, he’s confident that SA’s comparatively high yields make the securities a good investment against 10-year treasuries yielding 1.72% or UK 10-year gilts with yields of 0.82%. By comparison, the yield on SA’s R2030 bond was 9.53% as of 12.32pm on Thursday, just one basis point below its 2021 closing high of 9.54% reached on March 25. That’s also 108 basis points higher than the 8.45% close reached on February 4, which at the time was the lowest yield on the security since April 2018.
SA bonds are “clearly trading below fair value”, said Scott. “To us the risk is to stay in SA cash. With inflation likely to stay at around 4%-4.5% for at least the next few years, you’re going to be disappointed if you sit in cash over the next few years.”
The Reserve Bank is forecasting average inflation of 4.3% this year, below the midpoint of its 3%-6% target range. It also expects economic growth of 3.8% in 2021, after the 7% contraction in 2020 that was the worst in a century.
That should keep benchmark interest rates at a record low 3.5%, which coupled with subdued inflation should make SA nominal and inflation-linked bonds a good investment. That’s despite SA debt being rated junk, or below investment grade, by all three major ratings agencies.
“A lot of the negative news about SA is already priced into the bond yield curve, especially beyond the 10-year point,” said Scott. “SA is junk rated, but that’s why our bonds are offering 4% real yields, which is pretty good in global terms at the moment.”
While he does not expect the rand to “blow out to R17 or R18 to the dollar”, he predicts it will weaken gradually over the longer term. So far that forecast is holding up, with the rand little changed against the dollar this year, making it the second-best performing emerging market currency monitored by Bloomberg.
“The rand will probably weaken gradually in line with the inflation differential between SA and its major trading partners but with bouts of strength and weakness in between,” said Scott. “A lot also depends on the dollar.”
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