Demand for South African bonds surges on new government optimism

Demand for South African local-currency bonds is surging, driven by optimism around the country’s new broad coalition government and prospects for interest-rate cuts as inflation moderates.

Barely halfway through the year, net foreign purchases of debt have already surpassed the total for all of 2023. Demand has taken off since the African National Congress invited rival parties to help rule the country after losing its parliamentary majority in the May 29 election. 

Since the vote, the bonds have returned 8.5% in dollar terms, by far the best performance in a Bloomberg index of emerging-market local-government debt. Turkey has fared next best with a return of 3.9%, while the average is 0.5%.

“South African government bonds have experienced a remarkable rally on the back of the election, outperforming all other EM local markets,” said Christian Wietoska, a strategist at Deutsche Bank.

Investors are wagering that the presence of opposition parties may help the new administration tackle state ineptitude, power shortages and logistics snarl-ups that have hobbled economic growth.

The rand is the best-performing developing currency since the election, while South African stocks have hit record highs.

Non-residents have purchased R12.2 billion of South African bonds since May 29, based on settled trade data from exchange operator JSE Ltd.

That’s brought year-to-date inflows to R22.2 billion, exceeding the R16.5 billion registered last year. 

A sharp increase in orders at South Africa’s weekly bond auctions is further evidence of strong demand from both foreign and local investors.

The latest sale on Tuesday drew R11.5 billion worth of orders, more than three times the R3.75 billion of securities on offer, according to data published by the central bank. That’s the strongest demand in three weeks.

The yield on South Africa’s 10-year notes was little changed at 11.04%, around the lowest levels since February 2023 by 12:35 p.m. in Johannesburg.

Farzana Bayat, fixed income portfolio manager at Foord Asset Management in Cape Town, said the rally in South African bonds had trimmed more than 100 basis points off yields since the election.

The worst-case scenarios feared by investors — such as a radical policy shift to the left — had been avoided, she said.

This is also reflected in the reduced cost of hedging against the threat of a South African debt default, through the purchase of credit default swaps, according to Bayat.

“The market is pricing in a lower country-risk premium on bonds as reflected by the CDS, which has rallied from 370 to 300 basis points,” she said.

Meanwhile, inflation expectations for the next two years have declined, signalling progress in the central bank’s efforts to rein them in.

Average inflation expectations two years ahead — which the South African Reserve Bank uses to inform its decision-making — fell to 4.9% in the second quarter from 5.2%, a survey published July 5 showed.

The healthy gains already notched up by the bonds suggest that the potential for them to rise further may be somewhat curbed, said Deutsche Bank’s Wietoska. 

“Overall, we believe in a structural shift in South Africa,” he noted. “That said, we shift from overweight to modest overweight due to richer valuation.”