by Stafford Thomas, 19 June 2014, 07:18
INVESTOR sentiment is prone to abrupt change, as foreign investors in SA government bonds have shown in recent weeks. From being strong sellers, foreign investors swung to being strong buyers in May, a trend that has continued into the first half of June. The about-turn is reflected in net buying of SA bonds by foreigners hitting R15,4bn in the six weeks to June 12 compared with net sales of over R42bn in the six months to March.
“The foreign buying surge was unexpected,” says Albert Botha, Atlantic Asset Management fixed income head. “There is a lot of uncertainty, and [bond yield] volatility is very high.” SA’s looming foreign currency rating downgrade by Standard & Poor’s (S&P) was ignored. Net foreign buying in the 10 trading days prior to the downgrade hit R6,4bn, with buying of R3,65bn on June 6 the highest in a single day since October 2012.
“Because issues raised by S&P were flagged in December and widely known, the downgrade was not a surprise,” says Dave Mohr, Old Mutual Wealth chief investment strategist. It was also fortunate the downgrade came when sentiment towards emerging market (EM) bonds had improved markedly. Inflows into EM bond funds of US$2,1bn in the first week of June were the highest in one week for a decade, reports research firm EPFR Global.
It is a marked change from outflows of $17bn in the first quarter and $21bn in 2013 as a whole. The search for yield is back, notes BlackRock. It is a view broadly echoed by other key global players. Offering among the highest EM bond yields, SA is well positioned. Of the 14 countries in the Barclays local currency EM bond index, the yield on SA 10-year bonds (8,3%) is fourth-highest with only Brazil (11,8%) exceeding it by a big margin. The index’s average yield is 6,4%.
A renewed hunt for yield in EM bonds was sparked by the realisation that fears of a surge in interest rates in the wake of tapering of quantitative easing by the US Federal Reserve were ungrounded. “There is uncertainty about the economic recovery but I can’t see central banks raising interest rates sharply,” says Leon Krynauw, Sasfin Securities fixed income head.
Pivotal to the interest rate outlook is the Fed funds rate, the equivalent of SA’s repo rate. A move to lift the Fed funds rate, which has hovered at around 0% since late 2008, would set the trend for interest rates globally. Views on Fed policy are mixed. Reflecting the more general view, the US National Association for Business Economics forecasts the Fed rate by the end of 2015 at a still low 0,75% and the 10-year US government bond yield at 3,75%, up from 2,6% at present.
At an optimistic extreme is Bill Gross, CIO of Pimco, the world’s largest bond manager, who expects a Fed rate hike in 2016 at the earliest. Even then, he believes, the Fed will hold the real rate net of inflation at near 0%, not 2%-3% as in previous rate upcycles. Seemingly supporting Gross’s view is bold action by the European Central Bank (ECB) to underpin consumer and business borrowing in the eurozone and stave off deflation. The moves announced by ECB president Mario Draghi in early June include €400bn in cheap loans to banks as well as the dropping of the ECB’s key lending rate from 0,25% to 0,15% and its bank deposit rate to -0,1%.
There may be more to come. “If required, we will act swiftly with further monetary policy easing,” said Draghi. Krynauw says steps may include the ECB’s version of quantitative easing. The ECB’s cheap-money monetary policy is hailed as positive for EM bonds. “The ECB’s moves will accentuate the search for yield,” says BlackRock.