Why did SA’s bond markets react positively to the MTBPS?
The South African bond market faced material headwinds this year, most of which stemmed from country-specific risks. Global events made the environment even more challenging. By the time SA’s Minister of Finance released the Medium-Term Budget Policy Statement (MTBPS) on 1 November, domestic bond yields had experienced several volatile months. Broad reactions to the MTBPS have been mixed, but the bond market has reacted positively.
Deputy head of Fixed Income explains the factors contributing to the bond market’s response and why we can expect more good news from this asset class.
After several months of negative news ….
In 2023, load shedding and China’s struggling economy posed significant hurdles to South Africa’s growth, leading to revised growth expectations of around 0%. Tensions with the US arose from accusations that South Africa had loaded weapons for Russia aboard the Lady R vessel, leading to concerns of possible sanctions and increasing country risk premia. The US bond market also faced challenges, negatively affecting risk appetite globally. As a result, South Africa’s 10-year bond yields increased from around 10.5% after the February Budget to around 12% in October, with the yield curve steepening during the same period.
The MTBPS was tabled against this market backdrop, with consensus expectations that economic growth, budget deficit, and debt dynamics would be materially worse than National Treasury had budgeted for in February.
… the bond market cheered the MTBPS
The MTBPS showed these various fiscal risks have materialised, to some extent. The 2023/24 Budget deficit will be 1% wider than projected in February, while the gross borrowing requirement was about R50 billion higher. The outlook for debt-to-GDP was also revised higher, and is now expected to peak 4% higher at around 78%.
However, these revisions were better than the market had expected and priced in. The market interpreted the MTBPS as fiscally prudent, since National Treasury did not deviate from its previously-announced plan to reduce spending in the medium term and fund the higher wage settlements by reallocating spending within current budgetary constraints. The intention is to reduce allocations to various departments by about R85 billion in the next two years, which will generate consistent primary budget surpluses in the medium term. This comes with risks. No further SOE assistance was provided for.
The fact that National Treasury showed its determination to continue with fiscal consolidation in a challenging environment was well received by the bond market. The market was also positively influenced by Treasury’s decision not to fund the Budget deficit in the nominal and inflation-linked bond markets but to diversify the funding mix by relying on cheaper form of funding from floating rate notes, sukuk bonds, international financial institutions and drawing down on foreign exchange balances.
The bond market rallied after the MTBPS as the large risk premium built into the yield curve unwound.
More good news for bonds
At current levels, the bond market is still discounting various negatives. We expect it will rally further towards year-end, for several reasons.
Global developments are helping ease the pressure on the domestic bond market as inflation data is starting to show signs of a slowdown and major central banks are starting to indicate that they may have reached the end of rate hiking cycles. Global bond markets are rallying on the back of this, lending support to the local market.
Local factors generally support bond markets towards year end: weekly bond auctions are halted in the middle of December for the holiday season while about R120 billion of coupons will be paid over the next four months. In the absence of any new and unexpected idiosyncratic risks, and given the attractive starting yields on bonds globally and locally, we expect the asset class to be supported in the near term. Under these conditions, investments in fixed income assets are expected to deliver a real return, superior to those available from cash.