Bonds weather ratings cuts

• Fundamental factors supporting yields, say analysts

Local bonds have held up well since last week’s sovereign debt downgrades, surprising some analysts, while others say fundamental factors are supporting the bond market.

Local bonds have held up well since last week’s sovereign debt downgrades, surprising some analysts, but others say there are fundamental factors supporting the bond market.

The most important is the value local bonds offer, with the yield of the benchmark 10-year R186 at less than 9%, firming to 8.85% on Wednesday from Tuesday’s 8.93%.

The US 10-year is at 2.30% and the UK 10-year gilt at 1.04%.

Any appreciation in a yield when prices fall is a capital gain, or profit, to an investor, as prices rise when bond yields fall.

S&P Global Ratings and Fitch downgraded SA to subinvestment status last week, presupposing weaker yields. However, the weakness in yields occurred at the end of March on President Jacob Zuma’s cabinet reshuffle. The R186 yielded a best level of 8.31% before Pravin Gordhan was replaced as finance minister by Malusi Gigaba.

“Ratings matter for bonds but are by no means the most important factor,” said Old Mutual Mutli-Managers analyst Izak Odendaal.

He said the direction of fiscal policy was key. That meant any fiscal deterioration ahead of the medium-term budget policy statement in October or the February budget could cause yields to spike again.

“But the new finance minister has stated that fiscal policy would not change.”

Zuma’s cabinet reshuffle would not have a significant effect on fiscal policy in 2017-18, said Capital Economics analyst John Ashbourne. Parliament had already passed a 2017-18 budget, including a framework of modest fiscal tightening.

The market has seemingly shrugged off more adverse news, such as further downgrades, which could cause SA’s exit from the benchmark world government bond index. That will happen when both S&P and Moody’s cut the local currency rating to junk. So far, only the foreign currency rating is junk.

In such an event, the local bond market could suffer outflows of about $6bn from global bond index funds, which would weaken the local market.

Nomura analyst Peter Attard Montalto estimated the passive ratings-sensitive onshore investments in government bonds at $10bn. “This is only about 9% of the debt stock out of an estimated 38% foreign ownership of local debt.”

The inflation outlook plays an important role. Falling inflation, as well as the Reserve Bank’s recently restated commitment to inflation targeting, has reassured bond investors.

Technical factors support bonds, such as exchangecontrol limitations.

External vulnerabilities are low, with SA’s debt at 46% of GDP considered to be low compared with Brazil’s rising debt of about 70% of GDP.

The global search for yield has supported emerging market bonds, even in downgrade scenarios. Yields in Brazil and Russia have declined to levels lower than before their downgrades.