South Africans benefited from a powerful demonstration of our integration into global capital markets this week. On Tuesday the yield on the key 10-year US treasury bond fell from 4.63% to 4.44%. By the end of the day the 10-year RSA bond yield had followed suit, declining from 11.66% to 11.45%.
The yield on an RSA dollar-denominated five-year bond fell from 7.52% to 7.19%, leaving the yield spread with the US treasury bond, an objective measure of SA sovereign risk, slightly compressed. The dollar weakened across the board. And with higher bond values, share markets almost everywhere responded agreeably for investors and pension plans. The JSE gained nearly 2% on Tuesday and almost another 2% on Wednesday.
All of this on the news that inflation in the US had fallen by a little more than expected. The chances of further increases in short-term interest rates therefore fell away, as they have in SA, and long rates moved in sympathy. Should the US economy slow as sharply as slowing retail spending — as strongly suggested in a print released on Thursday — declines in US short rates should follow in short order, adding to dollar weakness and rand strength.
This might appear to be much ado about relatively little — a mere blip on the consumer price index (CPI) graph. If you could predict nominal US GDP and interest rates over the next 10 years you would be able to predict share and bond values with a high degree of accuracy. Such predictions would not be much affected by the failure of the Federal Reserve to manage inflation during the Covid-19 lockdowns. Or by what has been its near panic and confusing rhetoric in dialling back inflation, which so roiled the equity and bond markets in 2021 and 2022.
Perhaps the most intriguing feature of recent trends in US GDP has been the growing share of corporate profits after taxes in GDP. The ratio of these profits to GDP has nearly doubled since the early 1990s. Investors must hope managers, with the aid of the research & development in which they invest so heavily, can defend this profit ratio to add to share values.
Another question about the long-run value of US corporations and their rivals elsewhere relates to the cost of capital by which their expected profits will be discounted. Why long-term rates in the US have increased as much as they have this year is a puzzle.
It is not expectations of more inflation that have driven up yields. They have remained well contained below 3% a year, despite higher rates of inflation. Quantitative tightening — the sale by the Fed and other central banks of vast amounts of government bonds bought after the global financial crisis and during Covid-19 — is surely part of the explanation.
It is not only vanilla bond yields that have risen this year. Real yields — inflation-protected bond yields — have also risen dramatically from near zero early in 2023 to their current yield of more than 2%. Clearly, capital has become not only more productive of profits in the US, it has also become more expensive in a real sense, to counter productivity and profit gains when valuing companies. Will it remain so? That is the trillion-dollar question.
The gap between real interest rates in SA, where a low-risk 10-year inflation-linked bond offers a yield of more than 4%, and the US has narrowed sharply. Surprisingly perhaps, real interest rates in SA have not followed global trends. This at least makes for relatively lower costs of capital for SA-based corporations. That is good news, which we can only hope will lead to more investment.
• Kantor is head of the research institute at Investec Wealth & Investment. He writes in his personal capacity.
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