Bonds on rebound as supply dwindles

By Bloomberg

Robert Brand

South African bonds, the world’s worst performing debt this quarter, are rebounding as supply dwindles and investors bet yields have climbed enough to compensate for the risk of a credit downgrade.

The yields on the benchmark security due March 2021 dropped 36 basis points to 6.64 percent yesterday, after climbing to a three-month high on October 8, as labour unrest spread through the country.

The extra yield investors demand to hold the bonds rather than US Treasuries fell 22 basis points since October 8 to 497 basis points. Spreads for Mexican debt, which has a similar rating, widened 22 basis points in the period to 367 basis points.

The Treasury halts its programme of refinancing short term into longer-maturity debt today, while government bond auctions end on December 11, shutting off the supply of new securities until January 8.

Semi-annual interest payments in December on as much as R280 billion of bonds would support a rally that might extend into next year as the rand strengthened, Afrifocus Securities fixed-income analyst Michael Grobler said.

“Lower weekly issuance and the end of the switch auction programme open a window of opportunity” for yields to fall, while the coupons paid in December would boost funds available for buying, Grobler said on Tuesday. A stronger rand “will help the bond market to gain impetus”, he said.

Wider deficit

South African government bonds have lost 5.7 percent for dollar investors since the end of the last quarter, the worst performance out of 26 sovereign bond indexes, data compiled by the European Federation of Financial Analysts Societies and Bloomberg show. The loss in November is 1.1 percent.

The Minister of Finance, Pravin Gordhan, is battling to restrain spending and restore confidence in Africa’s largest economy after reduced tax income led to wider estimates for the fiscal deficit.

Moody’s Investors Service downgraded South Africa’s debt one level to Baa1 on September 27, and Standard & Poor’s cut its rating to BBB, the second-lowest investment grade, two weeks later.

Fitch Ratings, which is reviewing South Africa’s BBB+ grade, said on October 26 that the government’s failure to meet fiscal targets was eroding its strengths compared with peers.

The rand slumped to a three-year low on October 8 and yields jumped after the worst labour unrest since 1994 resulted in the death of 46 people at Lonmin’s Marikana platinum mine in August.

Illegal strikes spread to other platinum and gold mines, cutting as much as R12.5bn from export revenue and reducing gross domestic product growth by as much as 0.5 percentage point, Gordhan said earlier this month.

Investors looking past the threat of another credit downgrade bid for 3.7 times the R2.1bn of fixed-rate bonds on offer at the weekly Treasury sale on Tuesday, up from a bid-to-cover ratio of two a week earlier and more than the average ratio of three this year, Bloomberg data show.

Foreigners

Foreign investors have bought a net R3.7bn of South African bonds since October 5 after selling R2.7bn in the preceding two weeks.

“Demand for rand bonds has been resilient, despite the ratings downgrades and mining strikes,” Royal Bank of Scotland emerging markets strategist Mohammed Kazmi wrote in a research report.

The cost of insuring South African debt using credit default swaps dropped three basis points yesterday to 161, Bloomberg data show, signalling an improvement in risk perceptions. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent if a borrower fails to adhere to its debt agreements.

The rand will probably recover to become the world’s best-performing currency next year, from second-worst this year. The currency will end next year at R8.28 to the dollar, appreciating 6.8 percent from R8.86 on Tuesday, according to the median forecast of 31 analysts in a Bloomberg survey.

Yields on South African debt maturing in 10 years are forecast to decline 7 basis points to 7.03 percent. The currency weakened 0.7 percent to R8.9074 a dollar at 8.20am in Johannesburg yesterday.

More global stimulus might boost demand for South African assets next year, ETM Analytics analyst George Glynos said yesterday.

“After the late-September and early-October weakening, local bonds are offering some value to foreigners again,” Glynos said.

“Against a backdrop of international policies that encourage the deployment of capital into emerging markets, the rand is likely to outperform,” he added. – Bloomberg

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