Ninety One, the asset manager spun out of Investec in 2020 that oversees about R2.86-trillion, says SA bonds are still a good investment despite a deteriorating interest rate and inflation outlook.
Peter Kent, a fixed-income portfolio manager at Ninety One, says inflation has probably peaked despite hitting an almost four-year high of 5.9% year-on-year in December, the highest rate since March 2017 when it reached 6.1%. While that will put pressure on the Reserve Bank to hike rates, especially since the US Federal Reserve is expected to hike rates four times this year, Kent says higher borrowing costs aren’t necessarily a bad omen for SA bonds, which still offer very attractive relative yields.
“The most powerful factor in the bond market right now is valuation and the SA bond market remains cheap,” he says. “Our 10-year yields still offer a significant premium against cash as well as both our emerging market and developed market peers.”
While 10-year Treasury yields have ticked up to 1.83% in response to Fed rate hike expectations, when one factors in the US inflation rate that hit 7% in December, close to the highest in 40 years, the securities are rewarding investors with steep negative real yields. By contrast, SA’s 10-year government bonds due 2032 yield 9.8%, so even when one factors in inflation of 5.9% they’re still providing investors with real yields of 3.9%.
Returns from SA’s all bond index have also been strong for each of the past five years: 10.2% in 2017; 7.7% in 2018; 10.3% in 2019; 8.7% in 2020; and 8.4% in 2021. Kent says he expects this trend to continue in 2022 despite the money market pricing in a repo rate of 6.5% by 2024, which he says is “on the aggressive side”.
“The year ahead is likely to be very similar,” he says. “Income and valuation are very strongly supportive of the bond market and income funds in general at the moment.”
Ninety One is pricing in four 25 basis point interest rate hikes at a minimum in 2022, which would take the repo rate to at least 4.75% by year-end. Since this matches the consensus that the US Fed will lift rates by the same margin this year, local rate hikes should preserve SA’s yield advantage and support investor appetite for the country’s bonds.
Kent is also relatively optimistic about SA’s fiscal debt, saying on the current economic growth trajectory it should reach about 71% of GDP for the 2021/2022 fiscal year. While he says government finances are “not out of the woods just yet”, if economic growth comes in better than expected the fiscal position could improve further. By way of explanation, Ninety One estimates that an economic growth rate of 3% over the next seven years would take debt to GDP to 61% while a slip to 1% growth over the same time frame would push it up to 81% of GDP.
“The National Treasury has been very responsible thus far. They’ve banked the better than anticipated revenue receipts they’ve received, which has required less debt issuance,” says Kent. “But if we see some of the political noise translate into more government spending, then, as investors, we will have to take notice. We’re not worried about that at the moment but it’s a risk we’re monitoring very closely.”
When it comes to the rand, Ninety One has pencilled in a year-end exchange rate of 16.70/$ in their inflation forecasting models, but Kent says one shouldn’t be too bearish on the local currency given strong commodity exports and improving global economic growth. While he says likely Fed rate hikes are a risk to the currency, as this attracts investor capital back into dollar-denominated assets, he believes that since they are partially in response to improving US economic growth they could actually be supportive of emerging market currencies.
“You shouldn’t think that the rand is a one-way negative bet — last year was a case in point,” says Kent. “Emerging market currencies like the rand are cyclical. When the long-term part of the US rate curve rerates upward it’s usually a positive cyclical message and the [SA] currency doesn’t usually depreciate in response to that.”
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