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SA bonds: ‘There are supportive factors at play’

Despite the deteriorating fiscal situation being deeply negative for local government bonds: Futuregrowth.
Image: Shutterstock

A year ago, 10-year South African government bonds were yielding a little over 8.0%. At the height of the March market crisis, however, yields blew out to 12.4%.

They have since retracted to 9.3%, but the outlook appears unfavourable.

‘The single biggest risk facing domestic bond investors is domestic growth,’ said Daphne Botha, portfolio manager at Futuregrowth Asset Management. ‘The forecast for this year is showing -7% GDP growth. That is a terrible number for this country. It is unprecedented in the recent past.

‘Why is that a problem for bonds? The implication is that government revenue will drop. Companies are failing, people are unemployed, and not spending as much as they used to. Less spending means less VAT for government. Companies failing means less corporate taxes. And people losing their jobs means less personal income tax.

‘In order for government to balance its books, it will have to come to the bond market and issue more bonds, or go to the money market and issue more treasury bills,’ added Botha. ‘That is the negative component for fixed income yields.’

Fiscal deterioration

At the February budget, Treasury forecast a debt-to-GDP level of between 65% and 72% over the medium term. That, however, was before the Covid-19 crisis.

Now, debt-to-GDP is forecast at between 80% and 100% this year.

‘The thing we need to concern ourselves with is not that number in itself, but how it impacts bond yields,’ said Botha.

Futuregrowth’s projections are that yields on 10-year government bonds, which are currently around 9.5%, could climb as high as 14% next year. The chart below shows Futuregrowth’s modelled yields (in teal) against historical bond yields (in red). It also indicates the firm’s fair value estimates out to the end of next year.

(Click to enlarge)

‘The risk of bond yields going higher is incrementally more than bond yields staying the same or going lower,’ said Botha.

On top of this, foreign ownership of local bonds has been declining – from a peak of 43% of the market in 2018 to below 31%. This falling international demand potentially places additional pressure on yields.

Silver linings

There are, however, three, positives for investors.

The first is inflation, which, in Botha’s view, has moved ‘structurally lower’ in South Africa. Historically, inflation was the biggest driver of local bond yields, although fiscal risks have grown more prominent in recent years.

Nevertheless, if inflation remains low, that has a dampening effect on yields.

‘The second big positive factor affecting bond yields is the current account balance,’ said Botha. ‘It’s still negative, but we are moving towards a neutral or positive current account balance.’

The most significant positive, however, is the high real yields at which bond yields are already trading.

‘While the story is negative, we mustn’t forget what is already in the price,’ said Botha. ‘If you look at the 10-year rate, you can see it is well above its 10-year average. That is telling you this market is pricing in a lot of risk already.’

(Click to enlarge)

Patrick Cairns is South Africa Editor at Citywire, which provides insight and information for professional investors globally.
This article was first published on Citywire South Africa here, and republished with permission.

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Buying Govt Bonds (ie:Lend the ANC Anything) is pure insanity at ANY Interest rate :

I also considered buying bonds especially when the 10 year rate was above 12%, but then I realized that soon our debt will be unaffordable if we keep spending more than we get it, and I don’t trust the government to then cut back on spending at that point, so then the other way is fund it with printing money, and if they follow that route and and inflation just keeps rising then a fixed rate on government bonds is no longer that good idea, so I am staying away from Government bonds and to start considering ways to protect myself from runaway inflation as the probability of such a scenario keeps increasing.

Retail bonds? Or a bond tracking ETF?

The current bond market, technically is looking like Q2 1998 just before the Asian crisis and Tito coming from labour minster into the SARB.

10yr yields blew out from 10% or so to over 20%. There were very supportive factors then as well, Mandela was still president and the RSA rainbow euphoria was still very much running through RSA and the globe regarding SA.

We have broken a 20yr down trend, the March ‘pop’ in yields in my opinion was a shot across the bow. Fundamentally we are 10 times worse off today with what we have in Luthuli house. This political and socio economic landscape (wasteland?), is the polar opposite to what we had back then and deteriorating daily.

Our internal first targets on 10yr are 21.73% – we are using minus 14.6% GDP for the year admittedly, even if it is better at say 11.4%, the civil unrest could cause a bond flush like nothing we have seen. Lets not discuss medium term 2nd and 3rd tier targets.

It is human nature to be optimistic – people are far more comfortable going long stocks than they are shorting them as an example. But it does not hurt to look at 25-30yr charts, where we are and in what context fundamentally, to see what might and can happen here and prepare accordingly.

In my opinion the whole world is about to reap what they have sown with these idiotic lock downs. We are in for 6-9mths from hell – with very little in modern day historical comparison – thereafter we shall see.

I am with you on this one. The SARB will be stepping in where the foreigners are fleeing I think. The SARB will support bond prices “in the secondary market” with newly-printed notes. They will create liquidity “to support the economy” while in reality, they will protect the value of bank assets. The Federal Reserve is leading the way in this regard. Central Banks have become the lenders of last resort to governments after covid.

If yields rally substantially we won’t have a banking system left. Property values are on a slippery slope already. No business can afford higher rates. The banking system is balanced on top of this house of cards.

I would like to hear opinions on this, especially those who differ from me. I don’t like the implication of my conclusion.

It’s the consequence of the collapse of the 1971 Bretton Woods System Gold Standard by the Americans who saw a way on manipulating global economies via their originally printing money but now simply transferring it via a click of a mouse from the Fed to their banking system which then allowed further slicing and dicing by their fund managers and finance houses.

Can we do anything about it? No … can we profit by understanding the intransigence and opportunism of the US banking system? Yes, but with quick thinking and risk.

If money is merely a convenient exchange of value method and is no longer backed with hard assets, it has to rely on trust. The dollar is trusted so it is accepted throughout the World. The question is whether printing more is inflationary or simply catering for the demand in the World for an accepted medium of exchange? So far it seems that it is not inflationary so there is no problem but it has caused distortions in the investment World. The question is – what are the long term consequences? If it is inflation, there is going to considerable upheavals in the World in the future when dollars are removed from the system. I would say that the jury is still out.

“It is unprecedented in the recent past.”

We know “Unprecedented” means WORST but don’t you just love the way “recent past” now refers to EVER RECORDED IN HISTORY!

Got to agree with @edalsg…any investment in SA let alone SA Government, is Economical Suicide!

Unfortunately even a terrorist organisation has value…

People who are buying SA governments do not realise that they are supporting a terrorists organisation “anc” and punishing the hard tax payers who are paying the high yields.

Rather buy physical silver and gold and sit back and wait for the ANC gangsters to finish off the value of ZAR. Decent private storage essential.

End of comments.

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