By Brian Kantor
Between the SA bond market opening at 08h00 yesterday, long term interest rates went up and the rand went weaker in almost perfect unison, by about 2% or more as foreign investors sold RSA bonds as they were selling all other emerging market bonds. And then just before noon the heavy traffic reversed course – again in perfect unison. When the bond market closed in SA, the rand had regained nearly 1% of its opening value and the long bond prices were nearly 3% stronger. Of the emerging market bonds, the RSAs had served best by the end of the SA trading day with most of the peer group in negative territory, for example Turkish lira denominated long bond yields were the worst performer, up 36bps.
The Bloomberg screens below copied at 17h00 tell the story – in normalised percentage terms and in actual prices and yields:
The precipitating force adding to yields and global bond market volatility has been the further sharply higher move in US long dated Treasury Bond yields. The financial markets are struggling to cope with the initial steps in what may well be a return to something like normal yields on US Treasuries. How long this will take and where higher interest rates will come to rest are important matters of conjecture. With higher yields promised by the safest bonds, the search for riskier yield elsewhere loses some of its urgency: hence the move away not only from higher yielding emerging market bonds but also from higher yielding utilities and property companies. Another dampener for the higher yield market has been significantly higher long bond yields in Japan – despite QE – and a stronger yen.
But of particular interest is that higher yields on vanilla bonds in the US have been accompanied by higher yields on the inflation linked variety. The yields on long dated US TIPS (inflation protected bonds) have moved higher, fully in line with the inflation-exposed bonds. The TIPS are now offering a positive real rate of return – the real yields until recently were negative. Thus the difference in these yields – the extra yield on the vanilla bonds being compensation for bearing the risks that unexpectedly high inflation will erode the value of interest income – has not altered much at all. It is therefore expectations of stronger sustainable future economic growth rates and therefore increases in the real demand for capital, that are driving real returns higher.
Higher real returns on capital is surely good news about the US and the global economy because it implies improved growth prospects. Faster growth should augment operating profits, cash flow, earnings and dividends of globally focused companies. The improved bottom lines may well be expected to compensate for the higher costs of capital (or required returns) as interest rates rise.
However this was not the case yesterday. Global equity markets were in strong retreat. The JSE, in rands, lost over 3% of its opening value (though less in US dollars). What was also of interest was that the sharp turnaround in the value of the rand after midday had no easily observable impact on the JSE or the sectors that make it up – it was a deep red colour where ever you looked.
The global companies listed on the JSE, the SABMillers, Richemonts and BATs of this world, did not act as rand hedges either before or after noon. The interest rate sensitive sectors on the JSE – property, banks and retailers – also bled through the day even as the rand strengthened.
A comparison of the price performance of the different sectors of the SA financial markets this year is made below. The increase in long dated interest rates in SA, as reflected by the All Bond Index (ALBI) and its inflation linked equivalent (ILBI) has dragged down the Property Loan Stock Index from a near 20% gain in mid May to a mere 4% up on Monday. Bonds have suffered more than property while equities had done about as well as property by Monday’s close. Using month end data and the JSE at the close on 10 June, we show how the S&P 500 in rands has provided excellent returns this year, over 40% if dividends are included. The global plays on the JSE (the Industrial Hedges) have performed nearly as well while the resource companies, the commodity plays, and the interest rates sensitive SA plays have all lagged. These two groups of companies – those sensitive to interest rates or commodity prices – have both lost about 5% of their rand value since 1 January 2013. The weak rand has, perhaps surprisingly, not helped the commodity plays while, as would have been expected, it has damaged the prospects for the SA economy-dependent plays.
Conclusion
The outlook for the rand, the JSE and emerging markets will be determined by the usual mixture of global forces and SA political specifics (in SA’s case). The recent volatility in financial markets can be attributed to global forces. But the rand is off a much weaker base for SA reasons. The global tug of war between higher interest rates and better growth prospects appears to be under way. Our sense is that the growth team will win this tug of war over moderately higher interest rates in the US, to the advantage of the S&P 500.
The rand and other emerging market currencies, including the weak rand, may well benefit from strength in global equity markets – though not as easily from bond markets. The SA specifics wil lalso continue to influence the value of the rand. Any sense that the mining sector wil not be as severley disrupted by strike action than expected, could bring a degree of rand strength. Even a modest recovery in the rand and bond market will make it easier for the the Reserve Bank to keep its repo rate on hold. It should do so regardless of the exchange value of the rand that is beyond the influence of SA monetary policy – as should be apparent to all.