South African bonds volatile – but attractive

South Africa’s bond yields have been volatile in the new year, but several factors could make them attractive to investors in 2024.

Investec chief economist Annabel Bishop said South African bond yields are seeing volatility into the new year as seasonal risk-on is battling negative sentiment towards the country.

South Africa’s 10-year bond yield reached 10.99% by the end of 2023 from over 12.00% in October.

However, it has since seen some volatility in 2024, reaching 11.19% at the start of January and dropping to 11.00% in the second week of the year.

“Global and domestic market events have driven the modest volatility, while global concerns of economic weakness persist, and debt is rising,” Bishop explained. 

“In South Africa too, the government has budgeted for higher borrowings, undercutting fiscal sustainability.”

The OECD has warned that current public debt-to-GDP ratios stand at high levels from a historical perspective, and governments face mounting fiscal pressures stemming from multiple sources.

These sources include ageing societies, the climate transition and defence. Debt-service costs are also increasing as low-yielding debt matures and is replaced by new issuance.

It warned that, in the absence of government action, the level of public debt to GDP is set to continue to increase to high levels.

Sustained debt reductions are generally achieved through a primary budget surplus. 

However, on current plans, few countries are likely to achieve this in 2024/25, suggesting it will be more challenging to reduce high debt now than in the past.

“The recent increases in long-term interest rates are also a potential source of risks for many emerging market economies,” the OECD warned. 

However, anticipation of a global interest rate cut cycle has spurred foreign investor appetite in 2023.

Bishop said foreigners purchased $128.8 billion worth of emerging market debt over 2023 on a net basis versus a $1.4 billion net sell-off over 2022.

She said South Africa has also seen volatile non-resident flows over 2023, with quarters fluctuating between net inflows and outflows.

However, the rand has not recouped its losses after closing 2023 at R18.30/USD versus 2022’s close of R16.96/USD.

Sanlam fixed-income portfolio manager James Turp said the momentum of local bonds would continue into 2024, which will be a good year for South African bonds.

He explained that their high yields will attract foreign investors looking for returns as the Federal Reserve will begin to cut interest rates, making riskier assets and currencies more attractive. 

2023 was a difficult year for South African bonds, with rising interest rates eroding their value and the government increasing local debt issuance. 

The government’s growing debt burden also risks becoming unsustainable, reducing the attractiveness of local debt. 

However, South African bonds rebounded towards the end of the year, with the All Bond Index rising 5% in November. 

Turp expects this to continue into December as this is traditionally a good month for bonds as coupon payments come through and governments close bond auctions. 

This results in a lot of cash looking for a home, and South Africa’s high yields make its debt very attractive. 

These yields are likely to remain high, according to Turp, as the Reserve Bank delays cutting interest rates until after South Africa’s general elections next year. 

If rates are higher for longer and inflation decreases steadily, local bonds will be very attractive as their real returns will grow.