Too ex­pen­sive

Don’t bank on prof­its de­spite great fis­cal pol­icy

Finweek English Edition - - Economic trends & analysis - GRETA STEYN

GLOBAL MAR­KET VOLATIL­ITY HAS seen a flight to US gov­ern­ment bonds as in­vestors seek safe havens. But in SA, bonds weak­ened as sen­ti­ment soured to­wards emerg­ing mar­kets. Even so, bonds re­mained ex­pen­sive at the time of writ­ing and shouldn’t be seen as a place to make money if eq­ui­ties tank.

How­ever, SA bonds have had a mas­sive shot in the arm from bril­liant Gov­ern­ment fi­nances. That the fis­cus is run­ning a sur­plus and will be buy­ing back debt on a net ba­sis is a ma­jor plus fac­tor for the mar­ket. But this good news was largely dis­counted in Oc­to­ber last year, when Gov­ern­ment first dis­closed it was bud­get­ing for a sur­plus.

Some fur­ther strength­en­ing in the mar­ket oc­curred in Fe­bru­ary this year, as the Bud­get and the de­ci­sion to keep in­ter­est rates on hold com­bined to help bonds higher. (As bond val­ues rise, the yield or in­ter­est rate falls. In other words, a lower rate is a pos­i­tive de­vel­op­ment, im­ply­ing a cap­i­tal gain.)

The R157 bond, ma­tur­ing in 2015, was trad­ing at 8,70% amid rand weak­ness at the be­gin­ning of Oc­to­ber last year, but traded right down to just be­low 7,50% in Fe­bru­ary. The mar­ket tur­moil that started at endFe­bru­ary pushed the yield up to 7,75%. It was trad­ing just be­low that at the time of writ­ing.

The shorter-dated R153 was at around 8,75% at the be­gin­ning of Oc­to­ber 2006 and traded down to 7,79% in Fe­bru­ary be­fore climb­ing to 8,10% as sen­ti­ment soured. It stood at 8,08% at the time of writ­ing.

“There’s been a shud­der in emerg­ing mar­kets that was felt in the bond mar­ket.

But there’s been no dra­matic weak­en­ing, as in the old days. So far, there’s noth­ing to be wor­ried about,” says Coro­na­tion head of fixed in­come Mark le Roux. He says the re­cent mar­ket jit­ters, com­bined with the higher maize price and higher oil price, sug­gest a cau­tious out­look for the mar­ket. Bonds are very sen­si­tive to in­fla­tion data as in­vestors look for real re­turns.

Le Roux notes that the yield curve is in­verted, which means in­ter­est rates on longer-dated bonds have fallen be­low shorter-dated pa­per. If you put cash in a one-year ne­go­tiable cer­tifi­cate of de­posit, you could get 9,6%. It there­fore doesn’t make much sense to take on ad­di­tional risk by buy­ing longer-dated bonds over the same time hori­zon.

Le Roux notes that yield curves glob­ally are in­verted, which has a lot to do with ex­pec­ta­tions that the next move in in­ter­est rates in­ter­na­tion­ally will be lower. In SA, the mar­ket has also started look­ing ahead to a cut in rates, even if it will only take place 12 months from now.

“The ex­tent of the yield-curve in­ver­sion is ex­treme, given the strength of the lo­cal econ­omy,” says RMB As­set Man­age­ment head of fixed in­ter­est Jonathan Ste­wart. An in­verted yield curve is the­o­ret­i­cally as­so­ci­ated with a re­ces­sion, as the long end of the bond mar­ket starts to dis­count sharply lower short-term in­ter­est rates in fu­ture. That’s not the case in SA.

“The mar­ket is say­ing the in­ter­est rate hik­ing cy­cle is be­hind us. But it’s un­likely that much more yield-curve in­ver­sion will oc­cur.”

Ste­wart is tak­ing a rel­a­tively bear­ish view on bonds, es­pe­cially when look­ing 18 months ahead. But in the short term, he ex­pects the mar­ket volatil­ity to be a tem­po­rary blip be­fore the abun­dant global liq­uid­ity re­turns. In­ter­na­tion­ally, in­ter­est rates might even be cut.

But Ste­wart ex­pects the US econ­omy to pick up sig­nif­i­cantly at the be­gin­ning of next year, so that by the mid­dle of 2008, the US Fed­eral Re­serve will once again re­turn to rais­ing in­ter­est rates.

“US in­ter­est rates will then be taken to re­stric­tive lev­els.

“Liq­uid­ity will be tight­ened, which will hit deficit coun­tries such as SA,” Ste­wart says. He says bonds are not a buy at cur­rent lev­els, no mat­ter how pos­i­tive the bond sup­ply sit­u­a­tion.

From Gov­ern­ment’s side, the fis­cus is look­ing at rais­ing R24bn in long-term loans from the cap­i­tal mar­ket this fis­cal year. At the same time, it will buy back R33bn in debt.

How­ever, Gov­ern­ment is so cash flush, that the ques­tion is why should it go to the cap­i­tal mar­ket at all in the next fis­cal year.

Scru­tiny of Gov­ern­ment’s ac­counts re­veals that the fis­cus ex­pects to end the

In­ter­est rates on longer-dated bonds have fallen be­low

shorter-dated pa­per.

cur­rent fis­cal year with an un­prece­dented R74bn in the bank.

This money is di­vided into R28,5bn, which is kept with the com­mer­cial banks, and R45,6bn, which is kept at the Re­serve Bank.

The money at the Re­serve Bank will re­main un­touched, be­cause it’s in­tended as a mech­a­nism to keep cash out of the money mar­ket.

Short-term blip. Jonathan Ste­wart

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