The Fixed Income team manages the STANLIB Flexible Income Fund, which has started the year overweight (versus its benchmark) in bonds and modified duration. We believe the short end of the bond market is relatively expensive compared to cash, but the longer end (10 years and more) still offers scope for appreciation. The team has increased exposure to the credit market since late last year, as we see credit spreads contracting. Credit offers more attractive returns than cash. We also like inflation-linked bonds (ILBs), as we believe inflation has peaked.
The fund has taken an overweight position in offshore assets. The recent announcement that Kevin Warsh will be the next chair of the US Federal Reserve (Fed) is positive for the credibility of the Fed. Warsh was the best of all contenders for the job, as he is an orthodox economist with previous Fed experience. Although there has been some concern that he will be under pressure from President Donald Trump to cut interest rates aggressively, one man is not the institution. Warsh will have to persuade the other 11 governors on the Fed’s Federal Open Market Committee of the need for interest rate cuts. As a result, we think US monetary policy, under Warsh’s chairmanship, will go back to being boring and data-driven.
A year ago, the team was also constructive on the bond market, expecting a stable political environment, structural reform, GDP growth and a slowing, but not recessionary, US economy. Some of that optimism was misplaced. The US Liberation Day tariff announcements and disagreements among GNU partners over the National Budget caused the market to sell off sharply and we rapidly moved to underweight bonds. That turned out to be a costly move, because the market subsequently rallied quickly. But we constantly interrogate our positions and made a quick recovery to overweight bonds again, which resulted in good returns for the year.
There are several reasons for our decision to maintain an overweight position in South African bonds. One is the country’s adoption of a lower inflation target of 3%. We believe South African inflation peaked at 3.6% and could even fall below 3% in 2026, giving space for three or four interest rate cuts by the South African Reserve Bank – which is more than the two cuts that the market has priced in. However, local political developments are still a risk.
Another reason for bullishness on SA bonds is the improving fiscal environment, which is expected to be highlighted in the upcoming Budget. Structural economic reform is not yet priced into the market, nor is the possibility of a credit rating upgrade. The term maturity spread is still at 65 basis points, which is where it was a year ago – if there is a rating upgrade,that spread will tighten.
While a weakening rand presents risks, not only for bonds directly but also for its effect on SA’s terms of trade, the team is hedging the risk by buying dollars. However, the base case view is that the rand could strengthen over the next year.
Foreign buying of South African bonds has increased over the past year but is still not at historical levels. It will not revert to those levels unless the country regains its investment-grade credit rating from the agencies, which will take time.
