Fixed Income: Moody’s downgrade amidst an uncertain global backdrop
The market environment remains uncertain. Liquidity and solvency risks are investors’ main concerns, as money is withdrawn from riskier assets and geographies. Our defensive positioning places us in a strong position to weather the downturn and to take advantage of opportunities to benefit from a market recovery.
- Moody’s downgrade was not unexpected but the ratings agency maintained a negative outlook, which presents the risk of another downgrade in future
- The SARB announced further interventions to support markets by buying back government bonds, in an effort to provide liquidity, which has already led to reduced market volatility
- The South African market was further buffered from market volatility in the near term by the postponement of the World Government Bond Index (WGBI) rebalancing
- Our defensive positioning places us in a strong position to weather the downturn and to take advantage of opportunities to benefit from a market recovery.
Friday’s downgrade from rating agency Moody’s was in line with our expectations in light of the deteriorating state of the fiscus. Unexpectedly, this ratings agency maintained a negative outlook, which presents the risk of another downgrade in future.
In our view, the structurally weaker economic growth and the resultant weak revenue growth made this downgrade inevitable. Unfortunately, the COVID-19 pandemic has affected growth across the world with the risk of a global recession increasing. This will place further pressure on the South African fiscus and budget. South Africa’s budget deficit is likely to increase while our debt-to-GDP is set to rise significantly. The budget deficit for the 2020/2021 fiscal year opens up to -9.5%, which in our view, will place some pressure on the yield curve.
Despite the downgrade, it is important to consider the support government is able to offer to ensure we are able to achieve a more stable fiscus and economic growth, especially in light of the effects of the coronavirus pandemic on the economy. The South African Reserve Bank (SARB) has already announced a 100bps cut in the repo rate. The SARB also announced further interventions last week to support markets by buying back government bonds, in an effort to provide liquidity. This brought some level of calm to the markets and resulted in bond prices rising after the initial market shock.
Further to that, the SARB’s Prudential Authority relaxed the banks’ liquidity coverage ratios and reserve requirements. This could potentially free up to R320 billion, which will be made available to banks to support the economy, by lending more to consumers and distressed businesses at this time.
The measures introduced by the SARB seem to be working in the near term, as they have reduced market volatility. To this end we have seen a tightening of bid/offer spreads for South African government bonds. The South African market was further buffered from market volatility in the near term by the postponement of the World Government Bond Index (WGBI) rebalancing, which will now take place at the end of April and not the end of March. As only investment grade bonds are included in the WGBI, South African bonds will no longer form part of this index. Index trackers and other investors that are mandated to only hold investment grade bonds, will be required to sell South African bonds.
The effectiveness of the policy measures that have been put in place to support markets going forward will also depend on how quickly South Africa is able to contain the spread of the virus locally.
Click here to read an overview of the economic impact of Moody’s downgrade