Fixed Income Environment

Cadiz Asset Management Managing Director and Chief Investment Officer, Sidney McKinnon, provides insights into the fixed income environment.

US Federal Reserve Chair, Jerome Powell, has stated that interest rates will remain at their current elevated levels or potentially even higher until there is clear and convincing evidence that inflation has been effectively controlled. It is worth noting, however, that there have been fewer rate hikes globally recently. Notably, the US yield curve has flattened and continues to be inverted. Additionally, during the month of August, longer-term bond yields for the United Kingdom, Italy, and Germany also increased.

Dominating the news on the local market in August was the commentary coming from the 15th BRICS summit, although much of it was not market moving. One of the key developments arising from the summit was the inclusion of six new members into the bloc. These new members are Argentina, Egypt, Ethiopia, Iran, Saudi Arabia, and the UAE.

In the month of August, major asset classes experienced downward pressure due to several factors, including rising US bond yields, resilient US growth and growing apprehensions regarding South Africa’s fiscal balance. Headline CPI inflation of 4.7% in July, was down from 5.4% in June. The outcome was better than expected and reaffirms our view that we have reached the peak of the rate hiking cycle. The overall decrease in headline CPI was also broad-based and supported in July by food and fuel inflation being driven down by base effects.

The South African money market curve continued to flatten over the month of August driven by the rising anticipation that rates may have peaked. The trend was clearly reflected in the three-month JIBAR, which decreased by nine basis points, concluding the month at 8.36%, and the 12-month JIBAR rate which saw a decline of 35 basis points to finish the month at 8.95%. In addition, the 12-month average
T-bill rate also declined by 11 basis points during the final auction held in August, reaching 9.02%.

Local bonds were under pressure, with sustained net selling activity by non-resident investors. As a result, the nominal yield curve bear steepened, with the R2030 increasing by five basis points, while the R2048 rose by 104 basis points. The FTSE/JSE All Bond Index (ALBI) therefore produced a negative return of -0.23% for the month. The negative impact on the ALBI was particularly pronounced in the 12+ years and 7-12 years sectors, which delivered returns of -1.1% and -0.13%, respectively. Conversely, the 3-7 years and 1-3 years sectors posted positive returns of 0.74% and 0.91%, respectively, partially offsetting the overall direction of the ALBI.

In August, the inflation-linked curve bull-steepened, unlike the bear steepening observed in nominal bonds. The I2050 bond saw an increase of six basis points, while the I2025 bond declined by seven basis points. Among the different maturity sectors, only the back end of the curve (12+ years) decreased in August, returning -0.07%. In contrast, the 7-12 years, 3-7 years, and 1-3 years sectors posted positive returns of 0.55%, 1.26%, and 0.65%, respectively. The overall performance of the South African Inflation Linked Bond Index (CILI) showed a positive return of 0.45%, while the IGOV also recorded a gain of 0.42% during the same period.

Domestic inflation has been declining, but remains higher than the South African Reserve Bank’s desired mid-point level of 4.5%. In addition, risks to inflation are still to the upside as the rand remains under pressure against the US dollar and oil prices continue to rise.

The South African bond market has some challenges ahead. The low growth environment has widened the fiscal gap. Closing this gap will necessitate either an augmentation of government revenue through means such as taxation or a reduction in government expenditure. Both options are expected to be exceptionally challenging, particularly given the impending general election in 2024.