Low rates and South Africa: A persistent hunt for yield

As the global economy teetered on the brink of collapse over ten years ago, central banks unleashed (a then) unheard of monetary stimulus, effectively putting a lid on long term bond yields. Bond investors struggled to find a reasonable return without taking unwarranted risk.

Things recovered somewhat, however. At one point in late 2018 the United States (US) 10-year looked reasonably interesting at 3.2%. 

But it was a high-water mark. Without wanting to mix metaphors, it has been downhill since then.

A collapse in yields

Following the even more extreme recent central bank easing and collapse in global growth and inflation expectations from the COVID-19 crisis, yields have plummeted. 

I experienced a practical implication of this when last week my local bank here in Italy informed me that shortly my Euro deposits would be incurring a negative interest rate charge. 

There are two reasons for this collapse in yields. First, central bank support of the monetary system. Second, materially lower economic growth expectations. 

The Financial Times recently calculated that 86% of the global bond market is now yielding under 2%, compared with in 2008, when over 70% of the global bond market yielded above 4%.

Just 3% of the investable bond market today yields more than 5%, a level which is at all time lows and represents a massive drop from only a few years ago.

The obvious effect of this is that investors who traditionally have low risk thresholds will be pushed into increasingly risky parts of the bond market. Pension funds and insurance companies must meet their liabilities, retirees still have to live. 

Where does this leave South Africa?

South African borrowers have been enormous beneficiaries of this enforced risk taking. Scouring the globe for income yield, international investors have learned to live with corrupt governments, questionable central banks, global pandemics and swelling budget deficits. 

In mid-March credit markets froze, and the South African ten-year benchmark almost hit 12.5%. Nedbank Private Wealth strategists note that the SA 2030 benchmark bond since then is down substantially.

On 3 June it hit a low of 8.63% (yields move inversely to prices).

The outlook

Despite global yields such as the US benchmark remaining resolutely stable at all time lows, and indeed many European sovereign bonds such as Italian and Greek debt trading a markedly lower levels than a year ago due to the landmark EU Recovery Fund package announced last week, for South Africa it is rather different.

Nedbank strategists note that South African government bonds are substantially weaker since June, with yields having risen 50 basis points to over 9%.

This would suggest that even against a backdrop of ultra low yields and a hunt for income, investors are wary of South African credit worthiness. 

Those calling for quantitative easing and further monetary action from the SARB should watch out. While global factors can make lending to the South African government more attractive than at other times, ultimately the solvency of SA comes down to two fundamentals.

The two fundamentals

First, debt metrics and debt sustainability. Unless South Africa can meaningfully get on top of spending, narrow the deficit and improve debt to GDP levels, investors will continue to head for the exit.

Secondly, perceptions of monetary orthodoxy and money supply are critical. If the SARB is shown to be weakening and heeding the siren calls for quantitative easing, it will not be long until investor demand evaporates. Investors can see through the “free money tree” theory.

South Africa should be putting its house in order while the sun of global low rates is still shining, so it will be prepared for the next storm. 

Also read: Taking stock: A half year of two quarters balanced on a knife-edge

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