Cadiz Asset Management Managing Director and Chief Investment Officer, Sidney McKinnon, provides insights and updates on the fixed income environment.
During September, local bond markets faced adverse conditions due to a combination of domestic and international factors. The US yield curve remained inverted, indicating a potential recession. The 10-year US bond yield increased by 46 basis points to reach 4.57%, and the two-year bond yield rose by 18 basis points to 5.04%. In addition, European government bond yields experienced significant increases due to concerns about central banks prolonging high interest rates beyond earlier expectations. The German 10-year yield saw an increase of 38 basis points, while the UK 10 year bond yield rose by eight basis points.
On the domestic scene, the South African Reserve Bank (SARB) Monetary Policy
Committee delivered a hawkish tone, holding the repo rate at 8.25% at the September meeting, highlighting the looming risks to the inflation trajectory. Sticky inflation implies that average interest rates in major economies will remain elevated. Consequently, tighter global financial conditions are likely to persist thereby increasing the risk profile of economies in need of foreign capital investment.
Emerging markets, including South Africa, faced considerable challenges due to the risk off sentiment, elevated yields in the US and a stronger US dollar. Consequently, the Rand concluded the month at 18.92 against the USD, constituting a monthly depreciation of 0.25% and bringing the year-to-date Rand depreciation to 11.07%.
On the domestic market, capital outflows persist as non-resident investors disinvest from South
African assets. During September, foreign holdings of South African bonds decreased to
25.25%, down from a peak of 42.76% in March 2018. Notably, this peak occurred prior to South Africa losing its investment grade status, resulting in its removal from the FTSE World Government Bond Index (WGBI) and triggering a sell-off of South African government bonds.
All major asset classes, excluding cash, experienced unfavorable returns in September due to both global and local factors. The nominal bond yield curve bear flattened, which occurs when the short end of the curve rises more rapidly
than the longer end of the curve. Consequently, the FTSE/JSE All Bond Index (ALBI) reported a negative return of 2.37% for the month.
Examining the ALBI performance closely, the negative returns in the Index were more pronounced in the 12+ and 7–12-year sectors, which delivered returns of -2.99% and -2.87%, respectively for September, mirroring the trend observed in the previous month. The 3-7 year and 1–3-year sectors also experienced negative returns of 1.24% and 0.38%, respectively.
The inflation-linked bond curve bear steepened as the I2025 yield rose by seven points and the I2050 yield increased by 21 basis points. Correspondingly, the FTSE/JSE Inflation-Linked Index (CILI) reported a negative return of 1.09% for the month. The negative returns in the CILI were particularly prominent in the 12+ and 7–12-year sectors, yielding -2.31% and -1.02%, respectively. Conversely, the 3-7 year and 1–3-year sectors displayed positive returns of 0.2% and 0.39% respectively, serving as a partial offset to the negative returns observed at the long end of
The money market saw a steepening of the curve. The longer-dated Johannesburg Interbank
Rate (Jibar) evidenced a more rapid increase compared to the shorter-dated rates.
Three-month Jibar dipped by three basis points, concluding the month at 8.33%, while the 12-month Jibar surged by 33 basis points, ending the month at 9.28%. Cash returns, as measured by the Alexander Forbes Short Term Fixed Interest Index (SteFI), was the star of the month, with a return of 0.65% for the period.
The SARB revised its 2023 headline inflation projection downwards to 5.9%. Despite this adjustment, the inflation outlook is not without risks. Local inflation has shown a decrease, but still surpasses by far the South African Reserve Bank’s targeted mid-point level of 4.5%. Furthermore, risks to inflation are still to the upside as the Rand remains under pressure against the US dollar.
Oil prices also remain elevated as Russia and Saudi Arabia prolonged their unilateral oil supply curbs for the remainder of the year. The fragile risk assessment and uncertainty of major components of the inflation basket means that monetary policy is likely to remain tight unless inflation surprises significantly to the downside. Investor confidence has also taken a hit, and the ongoing depreciation of the Rand is exacerbating inflation risks. Consequently, investors now seek higher country risk premiums for South African bonds. All these factors, coupled with weak fiscal metrics, present a challenge for local bonds in the near term.