Global bond mar­kets

Finweek English Edition - - INVESTMENT - Port­fo­lio man­ager and head: in­ter­est rate process at Fu­ture­growth As­set Man­age­ment

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

(an­nual av­er­ages)

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.

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