2024: more to come from bonds

Despite a surge in bond prices towards the end of 2023, we retain a positive outlook on US government bonds at their current yields, and believe that South African government bonds (SAGBs) have more to give over the coming year.

Victor Mphaphuli

Head: Fixed Income

Bonds are anticipating interest rate cuts

We think US government bonds reflect a consensus expectation of a soft(ish) landing in which inflation keeps moderating, employment softens enough to allow the US Federal Reserve to cut, but growth holds up. Our positive outlook for Treasury bond returns is supported by the record levels of assets invested in cash and short maturities: assets held in US money market funds are a record US$6 trillion. The yields offered by these funds will drop as the Fed begins cutting rates, so investors will redeploy their capital at longer maturities to maintain their returns.

SAGBs will appreciate as policy rates come down all over the world and bond volatility fades. We project a total return from the 10-year SAGB of more than 14% over the next twelve months.

As shown in the chart below, the 10-year SAGB currently offers a 7.7% yield in US dollars (i.e. after the cost of currency hedging), the highest in its emerging market sovereign peer group.

We think that SAGB investors are being well compensated for the risks of fiscal slippage and that the credit default swap markets are sending a relatively sanguine message about South African sovereign credit, supported by the remarkably long average maturity of the government’s debt.

What happened in 2023

In soccer parlance, 2023 was a ‘game of two halves’. Markets began the year labouring under the prospect of rates staying higher for longer to combat sticky inflation, even as economies slid into recession. In May last year, the market delayed the anticipation of the US Federal Reserve’s (Fed) predicted rate cut by 10 months and reduced the expected cuts for 2024 from 230 basis points (bps) to 100 bps. Despite this, in our August client update, we reaffirmed our positive outlook on fixed income, despite concerns that strong economic growth and steady job numbers reinforcing the notion that the Fed might continue to postpone rate cuts. Towards year-end, inflation eased and US employment data softened, signalling a potential end to rate hikes. Markets quickly adjusted for lower rates in 2024, causing a surge in government bond prices. The US 10-year Treasury saw its largest rally in over a decade, with its yield dropping from 5% on October 19th to 3.87% by year-end.

One month into the new year, confidence is growing that central banks have stopped raising rates and will begin cutting them sooner than previously thought.

This would be a good time for clients who wish to move incrementally up the risk/return curve from money market and income fund strategies to consider investing in a well-managed fixed income fund that offers exposure to longer-term maturities. The STANLIB Flexible Income Fund or the STANLIB Income Fund provide access to longer-term investments and stable returns that beat inflation.