There’s still time to get into the year’s best bond trade.
That’s provided South Africa’s central bank lives up to market expectations and cuts interest rates, according to Morgan Stanley. The government’s rand debt has already made investors a total return of 13.9 per cent in dollars in 2018, more than double the gain for Mexican peso bonds, which are the second best among 19 major emerging markets tracked by Bloomberg.
South African bonds have also outperformed all nations in Bloomberg’s indexes for developed-world local-currency notes.
Yields on benchmark government securities dropped to the lowest level since May 2015 on Wednesday after a budget speech from Finance Minister Malusi Gigaba convinced investors that South Africa would avoid another downgrade to junk by Moody’s Investors Service next month.
Speaking in Cape Town, he outlined plans to increase value-added tax, boost revenue and narrow this fiscal year’s budget deficit from initial forecasts. It was the first budget announcement since Cyril Ramaphosa, who pledged to revive an economy that’s emerging from its second recession in a decade, was named president last week.
“A combination of better growth, lower inflation, and a central bank rate-cut bodes well for the local bond market,” Morgan Stanley analysts including James Lord and Min Dai said in a note to clients on Wednesday. “Coupled with a stronger rand and rate-cut expectations, we believe government bonds could have a strong rally.”
They see the yield on South Africa’s rand-denominated debt due 2026 falling to 7.7 per cent. The rate has already declined almost 150 basis points since mid-November to 8.03 per cent.
Citigroup Inc recommended investors buy rand notes maturing in 2041 and target a 75 basis-point drop in the yields to 8.2 per cent. The spending plans will probably convince Moody’s, the last of the three major ratings firms to have South Africa at investment grade, to keep it at that level, said Luis Costa, an emerging-market strategist at the New York-based bank.
After Gigaba’s budget speech, derivatives traders increased their bets that the central bank will cut rates. Forward-rate agreements beginning in 12 months fell to almost 50 basis points below the three-month Johannesburg Interbank Agreed Rate, all but pricing in two cuts of 25 points each in the next year. The last time the gap was that large was in September.
Standard Chartered Plc sees the South African Reserve Bank reducing its repurchase rate by 25 basis points at the next monetary-policy meeting on March 28. That would not put investors off the rand, which may strengthen another 6 per cent to 11 against the dollar, the London-based lender said in a note Wednesday. The currency declined 0.3 per cent as of 1:52pm in Johannesburg on Thursday to 11.6975 per dollar.
But not everyone is convinced global money managers would stay bullish on the currency, which has rallied more than 20 per cent since November, if the central bank starts cutting borrowing costs.
“The benign inflation outlook and likely rand rally off the back of no action from Moody’s is likely to see the central bank reduce its policy rate, removing some of the support for the currency and driving some carry-trade flows away from South Africa,” said Natalie Rivett, a senior analyst at Informa Global Markets in London.
The FTSE/JSE Africa All Share Index climbed 1.2 per cent on Wednesday and the cost of insuring the nation’s debt against default over five years extended a drop after the budget to 142 basis points.
Foreign investors bought the most South African bonds on Tuesday since October 2012, and were net buyers of local stocks for 11 days through Wednesday, Johannesburg Stock Exchange data show.
“It’s a decent budget in a very difficult environment; we’re still hoping that more changes will be implemented,” said Owen Nkomo, the chief executive officer of Johannesburg-based money manager Inkunzi Wealth Group. “We’ve done a lot of talking. It’s time to actually implement.”