Foreigners buy local bonds as dovish Fed sets off emerging market rally
Selling appears to be concentrated in big rand-hedge shares
FOREIGN investor interest in local bonds swung sharply from risk-off to risk-on in the first quarter. It brought quarterly net foreign buying of R17bn, led by net purchases of R14bn last month, one of the highest monthly levels in six years.
As welcome as a revival in foreign investor interest may be, it must be seen in the context of a rebound in emerging markets in general.
Emerging markets “are benefiting from the Fed’s dovish comments”, Investec chief economist Annabel Bishop says. Ms Bishop is referring to the surprise announcement by the US Federal Reserve’s open market committee on March 16 that it would hold its key federal funds rate lower for longer.
Also benefiting emerging markets has been a rebound in the oil price since January, and China’s move in February to stimulate its flagging economy.
The rebound in emerging market bonds that began in late January, followed 18 months during which the Barclays Capital emerging market bond index denominated in dollars fell by more than 20%. Local bonds fared far worse, with the MSCI dollar-denominated South African bond index falling 40% during the period. At work in part, was the rand’s slide.
Another big dose of pressure was added by President Jacob Zuma’s actions in December that resulted in SA having three finance ministers in four days.
As a result, the yield on the key R186 government bond jumped from 8.7% to 10.6%, its highest level since 2008, in less than a week. The yield on the R186 has since strengthened to about 9%, although this is weaker than the three previous highs seen in 2009-2014.
“Most of the strength in South African bonds is due to the emerging market rally and perhaps a bit of improvement in sentiment,” says Albert Botha, an Ashburton Investments fixedincome portfolio manager.
“I believe a lot of emerging market bond funds were underweight South African bonds.”
The rally is also strongly evident in equity markets. Reflecting this, the MSCI emerging market dollar equity index has rallied 20% since late January. It followed a 30% fall in the index since September 2014.
SA has followed the emerging market lead, with the JSE all share index rising 11% since late January and 25% in dollar terms on the back of a rand rallying from heavily oversold levels.
There is scant indication that this rally is attracting meaningful foreign investor interest in South African shares.
At best, it has moderated foreign selling; JSE data show net foreign sales fell from R11.1bn in January to R8.4bn in February and R5.2bn in March.
The precise sentiment of foreign investors towards South African equity is hard to judge, says Doug Blatch, the head of equity trading at Investec Asset Management. However, selling appears to be concentrated in big rand-hedge shares, such as SABMiller and Naspers.
Poor foreign investor interest in South African equity is in contrast to many other emerging markets. Indicative of this, the largest exchange-traded fund of emerging market shares, BlackRock’s iShares MSCI EM Fund, attracted $4.6bn last month. It was the highest in two years, and compared with an outflow of $5.8bn last year. The fund is dominated by Asian equity, which accounted for 68% of its $25.5bn worth of assets at the end of last month.
Asian markets are leading the emerging market rally.
“Emerging Asia saw inflows of $20.6bn (in March), fairly evenly split between equities and bonds,” Ms Bishop says.
Latin American bonds and equity followed at $13.4bn, with Brazil alone attracting $2bn, according to the Institute of International Finance. Africa and the Middle East trailed in last position, attracting $600m.