South African bonds headed for a rally

South African government bonds will rally further towards the end of 2023 as central banks show signs of reaching the end of their hiking cycles as inflation cools, and local bonds have very attractive yields. 

This is according to South Africa’s largest bond fund manager, Stanlib, which oversees R600 billion in assets. 

Deputy head of fixed income at Stanlib, Sylvester Kobo, said in a note to clients that the asset manager thinks the bond market has priced a significant risk premium into South African government bonds. 

Kobo thinks this is overly negative and expects bonds to rally further towards year-end on the back of the Finance Minister’s Medium-Term Budget Policy Statement (MTBPS). 

The MTBPS showed that many of the expected fiscal risks have been realised, with the government’s budget deficit widening, borrowing increasing, and debt continuing to rise. 

However, Kobo said these revisions by the Treasury were not as bad as the market expected and had priced into local bonds. 

The MTBPS was also consistent with the Treasury’s plan to reduce spending and implement fiscal consolidation. 

The intention is to reduce allocations to various departments by about R85 billion in the next two years, which will generate consistent primary budget surpluses in the medium term. 

However, this comes with risks, as no further state-owned enterprise (SOE) assistance was provided. 

Stanlib previously said most of South Africa’s SOEs are “in serious financial difficulty and will need government assistance sooner or later”. 

“By not making provisions for SOEs now, the Minister is simply delaying the inevitable and pushing the problem down the road.”

However, the fact that the Treasury showed its determination to continue with fiscal consolidation in a challenging environment was well received by the bond market, Kobo said. 

Global developments are helping ease the pressure on domestic bonds as inflation is slowing, and central banks are starting to indicate that they may have reached the end of their hiking cycles. 

Global bond markets are rallying on the back of this, lending support to the local market.

 Local factors generally support bond markets towards year-end, Kobo said, as weekly bond auctions are halted in the middle of December for the holiday season while about R120 billion of coupons will be paid over the next four months.

In the absence of any new and unexpected risks, and given the attractive starting yields on bonds globally and locally, we expect the asset class to be supported in the near term. 

Under these conditions, investments in fixed-income assets are expected to deliver a real return superior to those available from cash.