Run on Numbers: Government bonds - under fire

The Johannesburg Stock Exchange ( JSE) in Sandton. Picture: Timothy Bernard

The Johannesburg Stock Exchange ( JSE) in Sandton. Picture: Timothy Bernard

Published Oct 15, 2023


The latest conflict comes at a time when markets are jittery, and bond yields around the world are trading at multi-year highs. Israeli government bonds fell, with the 2120 ‘hundred year’ bond down 5.3c on the dollar at a record low. The shekel sank to its lowest since early 2015 at 3.9880 per US dollar, prompting the country’s Central Bank to offer to sell up to $30bn of foreign currency to maintain stability.

Not so long ago, families, businesses, and governments were effectively living in a world of free money. The US Federal Reserve’s benchmark interest rate was zero, while Central Banks in Europe and Asia even ran negative rates to stimulate economic growth after the financial crisis and through the pandemic.

The global bond market rout could have far-reaching consequences, impacting various asset classes and investment portfolios, despite the situation having stabilised somewhat for the time being.

  1. US bonds maturing in ten years or more have fallen 46% since peaking in March 2020, according to Bloomberg. European bonds are following in the footsteps of the US, with yields on Germany’s 10-year sovereign debt rising above 3% for the first time since 2011. Meanwhile, Japan’s 10-year yield rose to a decade high, despite the Bank of Japan being prepared to buy back $4.5 billion worth of bonds. Also surging this week have been Australian, Canadian, and UK government bond yields. When bond prices fall and yields rise, investors will experience losses in their fixed-income holdings, especially if these yield increases are of the current magnitude and come from a shallow base. CEO and founder of deVere Group Nigel Green said: “The sell-off began after the US Federal Reserve insisted that interest rates would be kept higher for longer. Carnage from the bond market— where the rout is worse than anything you’ll find in the history books — is spreading, and the implications are nasty. Bonds are suggesting a long and/or deep recession. There’s a growing worry that inflation is more stubborn than expected, and this has triggered the inverted yield curve in bond markets. Yields are inversely related to bond prices. This is typically the sign of a coming recession – an inverted yield curve has emerged roughly a year before nearly all recessions since 1960.”
  2. Steen Jakobsen, Saxo's Chief Investment Officer, sees the current situation of the long bond market as one of two extremes. One is that it provides a once-in-a-decade opportunity to go for long bonds. ‘’We are either at a four-decade opportunity to lock in rates at cycle high or at an inflexion point where we have a full paradigm shift to a Schumpeter moment of creative destruction in economic policy via government overreach.” Regarding other asset classes and the general economies in the world, one can only agree with Jim Reid, a strategist at Deutsche Bank AG. “I struggle to see how the recent yield moves don’t increase the risk of an accident somewhere in the financial system. So, risky times.”
  3. Locally, our Governor of the SA Reserve Bank (SARB) surprised us all by stating “that high-interest rates, which the SARB has been raising to curb inflation, did not affect unemployed people because they did not qualify to raise debt. The SARB’s Monetary Policy Committee has implemented 10 consecutive interest rate hikes since the hiking cycle started in November 2021, bringing the repurchase rate to a 14-year high of 8.25% to tame consumer inflation. It does recall the caution that is often quoted: just don’t throw the baby out with the bath water. South Africa’s benchmark (10-year) bond yield has jumped back above 12%, losing ground mainly in the second half of this year as government finances deteriorated. Although, higher US (10-year) treasury yields have also contributed to the weakness. Risk-off has elevated, and foreigners have increased net sales of SA bonds, ditching -R16.5bn worth (purchases less sales) since the ‎Federal Open Market Committee (FOMC) meeting on September 21. Government finances are under scrutiny, with expenditure remaining substantially higher year to date, at R883 billion versus R809 billion for the same period last year, the key deterioration. This means that the fiscal deficit for the year to date is R238bn, a hefty number that does not bode well for the current fiscal year.
  4. Markets are concerned that government finances have become unsustainable, with borrowing standing at 72% of GDP and set to rise to 74%. This is well above the 60% of GDP ratio that is sustainable for borrowing for emerging markets, while the vastly unaffordable National Health Insurance (NHI) adds to concerns of substantially over-borrowing further. The above comparison of the US and SA long bond rates should be seen in conjunction with the debt-to-GDP ratio of the US, which has breached 120% recently. The differentiator in favour of the US is the fact that their nominal interest rates are substantially lower than that of SA. Their service of debt ratio to GDP is, therefore, much more favourable than that of SA. South Africa spends a vast amount of their revenue on government salaries and debt servicing, and there is no more room for expansion. Exceeding the budget deficit this year would likely incur additional borrowing, with increased supply reducing the value of bonds. The The Organisation for Economic Co-operation and Development (OECD) notes overall, “governments face mounting fiscal pressures. Public debt levels are generally higher than before the pandemic, with the burden of servicing debt continuing to rise.” The drain on resources from local state-owned enterprises’ (SOE) is often talked about by Pravin Gordhan, and although he is a chemist by trade, he has difficulty in administering stronger medication in his public enterprises portfolio.
  5. The JSE has introduced sustainability bonds to the market. Its web page states, “Sustainability-linked bonds are debt securities where borrowers, usually governments or large corporations, issue bonds to fund sustainability-related initiatives. These are fixed-income investments that trade on the bourse’s Interest Rate Market. There are various types of Sustainability-linked bonds. These sustainability-linked debt securities are bonds whereby the proceeds from the issuance can be earmarked for green or other sustainability purposes.

As South Africans, we have overcome many adverse situations in the past. A fund manager who now starts to sell bonds has most probably missed the bus. As they say, if you want to panic, panic first. The current high yields provide a nervous opportunity that may not present itself for a long time.

* Kruger is an independent analyst