Global bond markets
For investors in the fixed-income market, t he out l ook f or inf l ation and the resultant monetary response – whether the Reserve Bank decides to change interest rates – matter most.
Put simply, if the market expects inf lation to rise in the future, interest rates and bond yields will rise (and prices will fall) to compensate for the loss in purchasing power of future cash flows (the interest payments and bond repayment). In an environment where the inf lation outlook is reasonable, investors therefore feel more comfortable to buy longer-dated bonds, as they expect the risk of rising inflation eroding their returns to be low.
October turned out to be a very strong month for global bonds in general and the local bond market in particular. Locally, the yield on the benchmark R186 (maturity 2026) declined sharply from an intra-month high of 8.35% to end the month at 7.88%. Yields moved in tandem pretty much across the curve, resulting in the JSE All Bond Index delivering a return of 3.4% against a cash return of 0.5%.
The st rong bull ra l l y i s i n part explained by events on major global bond markets. In the US, the yield on the 10-year Treasury bond briefly dipped well below 2%, its lowest level since May last year, before settling at 2.3%, still 20 basis points below the September close.
Concern about the inability of global growth to gain t raction and r ising def lationary fears spooked markets and contributed to the latest f light into bonds.
The l oca l bond r a l l y was a l s o underpinned by interest-rate-friendly data releases and events. Of these, a lower-than-expected September headline consumer inf lation data release (5.9% from the previous month’s 6.4%) and Treasury’s stated intent to intensify Global GDP USA Euro area Japan China f iscal discipline in the latest MediumTerm Budget Policy Statement were the most important. A much-lowerthan-expected monthly external trade deficit and continued slow expansion of the monetary base were minor positive drivers.
The sharp drop i n the crude oil price, driven by a mixture of supply and demand dynamics that dwarfed geopolitical concerns, served to further reduce inf lation expectations both globally and here at home.
It i s ver y e v i dent t hat s t r ong disinf lationary forces are still at play globally. In turn, this is the result of a mismatch between a structural oversupply of goods and weak consumer demand, while competitive ‘ devaluations’ are contributing to the disinflationary cycle.
Moreover, falling commodity prices and in particular the sharply lower crude oil price adds a strong cyclical colour to the disinf lation theme. Apart from a few, most central banks have no reason to raise official rates soon and as a result, the global savings glut may very well be around for a while. Even on the f iscal side, most governments are in f iscal consolidation mode, despite a broadly based fragile economic recovery that calls for the opposite.
The South African backdrop is very
2015 3.0% 1.8% 1.4% 7.3%
2016 2.7% 2.0% 1.5% 7.0% similar. We have now turned particularly bullish on the local inf lation outlook. Headline consumer inflation is expected to grind lower from the recent cycle peak of 6.6%. The recent unexpected sharp drop in crude oil prices pushed our 2015 annual average forecast from 5.6% to 5.3%. The forecast for next year assumes a crude oil price of $95 a barrel, food prices rising by 5% and a 13% increase in Eskom tariffs.
We also have no good reason to believe that the twin deficit situation will get worse on a medium-term view (see table).
Signif icant rand weakness since mid-2011 and the slow, albeit fragile, global economic recovery is paying some dividends by boosting merchandise exports and net tourism receipts. However, progress is still partly offset by low eurozone growth, local supply disruptions and the high import content of large infrastructure projects.
Our main strategy therefore remains to further increase fund modified duration by buying ultra-long-dated nominal bonds into bouts of market weakness.
We will reduce our cash holding in the process. Although the slope of the nominal yield curve has f lattened over the last few months, we continue to believe that it still offers decent value, especially relative to cash and inflation-linked bonds.