You're listening to Strictly Business Podcast with Lindsay Williams.
Developed market bonds are behaving, well, not badly, that's the wrong word,
but in some cases erratically and different durations are in sharp focus for
investors,
particularly in the United States.
But what about South Africa?
With me is Ruan Naidoo, Portfolio Manager at 91 in Cape Town.
Is it too fanciful for me to say, Ruan, that...
Compared to developed market peers, certain developed market peer markets
anyway,
the South African bond market is almost like a safe haven and has been since early
April.
Good day, Lindsay.
That's quite correct, actually.
Developed market bonds have come under considerable pressure in recent weeks,
and particularly at the long end of the curve.
And I think the stress here has been driven by mounting concerns over fiscal
deficits and rising did.
burdens, both France and the UK, as well as
Japan, have been grappling with budgetary strains.
And in Japan, you kind of see a bank that is behind the curve on inflation.
And as you point out,
the US has not escaped this sharp steepening in the yield curves and selling
off.
And that has largely reflected worries about the Federal Reserve independence, as
well as legal challenges surrounding turf.
policy.
And you're quite right.
In contrast, South African government bonds have been notably resilient.
The long end of our yield curve has outperformed the developed market
counterparts.
And that's really been supported by, I think, our country's commitment to very
orthodox economic policy.
Yes, I saw that in the note that you sent me,
orthodox in terms of the actions of the Treasury and the South African Reserve
Bank or just the Reserve Bank.
Tell us more, please.
It is a combination of both monetary policy and fiscal policy.
The South African Reserve Bank has long been regarded as fiercely independent,
targeting inflation and committed to bringing inflation expectations down over
the long
run in a very orthodox monetary policy fashion.
Most recently, the Reserve Bank has made a decision
to start focusing on the lower end of our inflation target band.
In 2017, they moved from focusing on the top end of the band to four and a half.
And this year, they've moved from four and a half all the way down to focusing on a
3%
inflation target, so to speak.
At the same time, if you look at our national treasury,
we've had successive years of a commitment to fiscal consolidation, trying to get
our...
debt to GDP down over time by generating primary surpluses within our
budget.
And this recent interaction between National Treasury and the Reserve Bank,
coming up with the joint statement last week, speaking about a move to a lower
target over time,
has also bolstered investor confidence.
Very good.
There is a vulnerability, of course, and the vulnerability comes from many
quarters.
It can be political.
I mean, we had all the optimism of the government of national unity, and then a
few cracks started to appear,
and that became apparent in the performance of bonds and also equities.
And there's also the RAND, of course.
The RAND has been stoic.
It's been very strong, certainly against the US dollar, but that's mainly, I think,
because of dollar weakness.
But that can change.
And a run on the RAND can mean a run on the bond market, Rune.
Yeah, this is quite right.
Like, for example, within our diversified income fund,
we typically do use dollar RAND as a hedge for our government bond duration in South
Africa.
What we found ourselves doing over the course of this year is actually migrating
some of that exposure to
non-US domiciles.
So we have been purchasing euro dollars, for example,
as a more appropriate hedge for a risk-off situation in South Africa.
And that's largely been because of the bear market that we've seen in the dollar.
There's been concerns about the end of U.S.
exceptionalism.
But I think more importantly,
it has been the deterioration of the institutional integrity in the United
States that has taken a rather
shine off the dollar.
So yes, South African bond markets will remain susceptible to sell-offs in the
currency.
But as we sit here with precious metals rallying quite aggressively,
with the oil price coming off, terms of trade is actually in the favor of South
Africa.
And moving to a lower inflation target over time improves the purchasing power of
South African rands and does add a bit to the currency over time as well.
So we think there are interesting supports for dollar rand at this point or the rand
in general.
And that has led to some adjustments in portfolio construction.
It's very interesting you talk about, you actually use the word integrity when it
comes to the United States of America.
and the august institutions of, for example, the US Federal Reserve, the
Bureau of Labor Statistics,
and maybe next is the people that collate the inflation data.
Who knows what the administration in the White House will target next?
I don't see that going away, personally, Ruan.
So the dollar's, to me, not going to embark on any period of strength quite
soon.
No, I don't think so.
you could get sort of sharp pullbacks in the dollar more broadly against other
currencies.
But I would put that down to short-term position squaring.
I think right now it is quite consensus to have bearish dollar trades.
And sometimes those positions get a bit overcrowded and there's a short-term
washout.
But I would look for those as opportunities to re-engage in bearish
dollar trades.
I think the Rubicon was really crossed when...
The president attempted to fire
Governor Lisa Cook on the back of potential mortgage fraud.
I think that really did shake markets and it certainly did shake my perception of
the institutional integrity
in the United States.
Okay, so just to summarize the developed market situation, well, the ones that
we've spoken about, we've got
France losing another prime minister.
I think that's the fourth in a very short space of time.
Anyway, Japan has lost a prime minister.
The United States are waiting keenly the U.S.
Federal Reserve decision.
I think it's on September the 17th. And so there's a lot of turmoil overseas.
But meanwhile, as we pre-record this podcast, the
10-year South African bond is around about 9.50.
And it was five months ago, Ruan, that it was just above 11%.
What a performance.
Yes, it has been a phenomenal performance in the South African government bond
market.
I mean, if we look at post-Liberation Day moves, the R2035 bond,
the 10-year bond in South Africa,
has fallen in yield by over 150 basis points over that period,
which is just incredible.
Over that same period, United States 10-year bonds have actually risen in
yield.
Same for Germany, same for the UK, same for Japan, where 10-year bonds have risen
by
38 basis points.
And if you look out to the 30-year sector,
Japanese yields have actually risen by 98 points versus South African bonds going in
the opposite
direction, which is simply incredible for a bond investor to witness.
How does that affect your positioning for the Diversified Income Fund?
What's your strategy at the moment?
How are you positioned, please?
Yes, so we have been quite constructive on South African government bonds over the
course of this year,
and we remain so right here.
We think that the curve still has room to flatten.
There's still an excessive amount of risk premia at the long end of our yield curve.
And while we might be susceptible to short-term steepening in developed
markets,
we will hedge for that from time to time when those risks present themselves.
But we do think with our yield curve sitting at a spread of about 250 points
between our
30-year and our 10-year is simply the steepest curve on planet Earth and bakes
in a tremendous amount of
risk premium that we think will come out over time as this African government bond
market is given the
benefit of the conservative policy that we have in both the fiscal and monetary
space.
Ruan, thanks so much for your time.
Ruan Naidoo is a portfolio manager at 91 in Cape Town.
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