Bond Market: The Landing is of Interest

In the US, the annual inflation rate hit 11% at the end of the 70s and Paul Volcker, the 12^th chairman of the Federal Reserve (US Fed) bank started steering the market, perhaps unknowingly, towards a hard landing. To combat inflation at the time, the fed funds rate (equivalent to our repo rate) was hiked to record highs and reached close to 20% per annum. By 1983, Volker’s US Fed was successful in pulling back inflation to 3%, but what followed was a 16-month recession – the first of the double deep recessions in the 80s – while unemployment reached 11%.

Going into 2023 many investors feared that history would repeat itself – that the aggressive rate hikes experienced in 2023 would lead to a recession, or a hard landing. Despite the historical parallels, markets priced in a soft landing – a marginal GDP correction at most, with limited impact on employment numbers. While this soft landing may yet occur, it might require a long runway if it in fact lands.

Missing out on bond exposure is a potential risk

One asset class that should sit at the top of everyone’s watchlist, especially in an environment pricing in a possible rate cut environment, is bonds. Once central banks start cutting interest rates, the existing bonds will likely appreciate as their yield will be more attractive compared to newly issued bonds that are basing their coupon payouts on lower rates. Given the recent returns on bonds, it seems that the risk for investors is missing out on participating in fixed income exposure.

Diversifying away from equities can potentially sacrifice real returns over the long term, but currently, bonds have come up head-to-head with equities when considering their historical returns, while having lower volatility. In the last 10 years, in a declining global inflation and interest rate environment to the end of February 2024, the FTSE/JSE All Bond Index returned 8.1% per annum, 0.2% higher than the FTSE/JSE All Share Index over the same period.

Bonds are outperforming, yet the major difference here is not returns but risk. In the same 10 years, investors would have experienced almost 78% higher volatility in equities than bonds.

There are some positives, in Southern Africa

South Africa goes to the polls this coming May, which will see one of the most contested national elections since 1994. Our next door neighbour, Namibia, has historically been intimately linked to South Africa when it comes to economic indicators, and with that, the country is also going to the polls this November. Growth in Namibia has been robust since the pandemic, primarily driven by its mining sector, owing to favourable commodity prices and promising oil and gas exploration.

The repo rate arbitrage between Namibia and South Africa is not one to look past though, as the country is 50 bps behind the SA borrowing rate, resulting in Namibian banks placing overnight balances mostly in South Africa as they can get a better rate. This difference in rates also means that once the South African Reserve Bank (SARB) starts cutting rates, Namibia will not be as aggressive. This is reflected in Cirrus Capital’s rate forecasts for Namibia as well; as the current rate in Namibia is 7.75%, Cirrus Capital sees Namibian borrowing rates remaining the same throughout 2024 and then some adjustments down from the year 2025 with the rate hitting 6.75% as the lowest the Bank of Namibia (BoN) will go at end of 2026. Diverging away from South Africa, the growth in Namibia could remain persistent, with Cirrus forecasting its real GDP growth to remain above 5% until the end of 2027.

Namibian assets had a stellar performance last year as the S&P Namibia Sovereign Bond 1+ Year Top 10 Index had a one-year return of 13.7% to the end of February 2024 while the S&P South Africa Sovereign Bond 1+ Year Index delivered a total return of 7.5% for the same period. It is worth keeping in mind though that this difference in return is likely due to a higher risk and liquidity premium required by investors to hold Namibian debt instruments.

A big consideration needs to be given also to the growth prospects of Namibia as opposed to the timing of the interest rate cycle. Growth in the country could mean that its deficits are decreasing or have decelerated compared to the past, this then can translate to the government issuing a lower supply of bonds, thereby limiting supply, which can push the prices up.

Simple exposure to bonds through Satrix

Investors looking for exposure to the bond market have options, in the form of Exchange Traded Funds (ETFs). The recent volatility in inflation may have pushed investors to consider bonds not only as a diversifier but also as an asset class that can deliver inflation-beating returns.

Satrix offers investors two local nominal bond alternatives: the Satrix GOVI ETF, tracking the FTSE/JSE All Bond Government Index and the Satrix SA Bond ETF that tracks the S&P SA Sovereign Bond 1+ Year Index. For those interested in securing real returns, the Satrix ILBI ETF tracks the Inflation-Linked Government Index. For non-Namibian residents, both foreign institutions and retailers can get direct exposure to Namibian bonds but the process is via scrip settlement (materialised). There is a dematerialised way to get exposure in Nambian bonds, which is done using the Satrix S&P Namibian Bond ETF. On the offshore side, Satrix offers the Satrix Global Aggregate Bond ETF, which tracks global interest-bearing assets (with 18% exposure to US Treasuries and 10% to Japanese bonds, while also including investment grade credit instruments). This has a no-minimum entry, is cheaper and provides liquidity.

This article was first published on the Satrix website.

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