Dissipation of political risks has made room for interest-rate cuts
• Local bonds offer attractive yields and cyclical and secular tailwinds should provide support
The relief rally in the currency and bond markets following the ANC’s conference in December was spectacular: the South African bond market returned an impressive 5.7% for the month, followed by a respectable 5.86% in the first two months of 2018. Is further Ramaphoria justified or has the time come for a more defensive position on domestic bonds?
We believe there are cyclical and secular tailwinds that should provide further support for the bond market over the short to medium term. Despite the significant rally in domestic bonds, emerging-market bond yields have fallen substantially more than ours over the past two years, suggesting that South African bonds continue to offer relatively attractive yields.
In terms of cyclical support, the relative political stability we’re enjoying after President Cyril Ramaphosa’s victory means we can finally divert our attention from the politics to the macro drivers. In particular, it means the Reserve Bank can shift its focus to more orthodox inflation targeting rather than having to run monetary policy on a risk-management basis.
As the “only adult in the room” over the past few years the Bank had to provide a steady anchor in an environment of surprise cabinet reshuffles, foreign flows, credit downgrades, instability at the Treasury and mismanagement of key stateowned enterprises.
In all of the monetary policy committee’s statements over the past year, the inflation risks were often to the upside on the back of unpredictable politics and downgrades and their likely negative effect on the rand.
Now these risks have dissipated, which means the Reserve Bank finally has the breathing room to consider more orthodox macro drivers of monetary policy. The good news is that there is scope to ease.
Due to the Bank’s prudent management of a tumultuous few years, inflation is under control in the middle of the target band, while growth — albeit better than expected and improving — is still very low and below our potential. Given this, a rate cut is unlikely to be inflationary very quickly.
So growth is improving, which helps the credit worthiness of the fiscus, but not at a rate that warrants monetary tightening. In other words, we are growing at the perfect speed to support the bond market from both a creditworthiness perspective and from a monetary perspective.
Over the longer term the bond market should find further support in actual deliverables. We believe Moody’s should give us a reprieve in March, which provides Ramaphosa and his new Cabinet with time to implement these changes.
The initial moves have been positive, but we need to see actual delivery. A positive signal, for example, would be for Eskom to come to market and successfully issue some debt again. We also need the Mining Charter bedded down; there is clear intent from labour, the government and business — and once passed, it should lead to capital investment. Money follows money, and would feed into other sectors of the economy, ultimately leading to confidence returning.
The Investec Diversified Income Fund, our flagship fixedincome strategy, has been positioned positively towards assets sensitive to interest rates, recognising that this was one of those rare opportunities where cyclical and secular factors were aligned. We continue to hold an overweight position in bonds and South African-centric listed property.
Ironically, just as local factors are starting to gain momentum, we believe that more caution will be warranted over the second half of the year, as the global environment is likely to become less supportive. In this event, we hold an offshore allocation, which should provide comfort that we can preserve capital.
For now, however, let’s enjoy these tailwinds that are likely to continue providing positive momentum for our bond market in months to come.
THE RESERVE BANK FINALLY HAS THE ROOM TO CONSIDER MORE ORTHODOX MACRO DRIVERS OF MONETARY POLICY