Don’t bank on profits despite great fiscal policy
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
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