Farzana Bayat, Portfolio Manager at Foord Asset Management
Rising debt burdens across developed and emerging markets are reshaping the fixed income landscape. In the United States, government revenue of around $5 trillion is set against expenditure of $7 trillion – a $2 trillion annual shortfall. That fiscal gap, which widened post-Covid, mirrors the trajectory seen in South Africa during the Zuma era, when spending escalated to unsustainable levels. Once public finances unravel, restoring discipline becomes extraordinarily difficult.
Policymakers in Washington show little appetite for fiscal restraint. Instead of cutting spending, the reflex has been to stimulate growth through lower interest rates. This lack of fiscal discipline is evident globally and represents a significant risk for bond investors.
The end of easy money
What makes the debt dynamic more concerning is the end of the ultra-low interest rate era. For more than a decade after the global financial crisis, rates were close to zero and debt servicing costs were negligible. That is no longer the case. Today, around 20% of US government revenue is spent purely on interest payments crowding out spending on critical services like healthcare.
Markets are starting to push back. In April, a tariff-driven risk-off episode saw bond yields rise even as the dollar weakened — the opposite of its typical safe-haven response. It was a warning sign that investors are questioning the sustainability of America’s fiscal position.
South Africa’s debt trap
South Africa faces the same headwinds. Government debt has ballooned sixfold in 15 years to almost R6 trillion, yet growth remains anaemic. Budget revisions underscore the pressure: tax revenues are faltering, households and corporates cannot be squeezed further, and demands on frontline services such as healthcare and education keep rising. Already, R22 of every R100 in tax revenue is spent on servicing debt before a cent is allocated to service delivery.
Debt stabilisation requires stronger real GDP growth or higher inflation, as both feed nominal GDP. Yet neither is in sight. Growth has averaged just 0.7% over the past decade, with forecasts still below the 2–2.5% required to stabilise the debt trajectory. Meanwhile, the South African Reserve Bank’s proposed 3% inflation target risks suppressing nominal GDP further. This argues for caution on long-dated government bonds, which are most vulnerable to fiscal drift and weak growth.
Why Inflation-Linked Bonds Shine
Amid this turbulence, inflation-linked bonds (ILBs) stand out as one of the most compelling opportunities in fixed income. Real yields are now around 5% – the highest in 25 years
ILBs are unique: they are the only asset class that guarantee a real return. For multi asset funds benchmarked to CPI, they are a natural building block. The ability to lock in a 5% real yield on a low-risk, government-backed asset is both rare and compelling in today’s world of high debt and policy uncertainty.
Breakeven inflation levels reinforce the case. Five-year breakevens have fallen from 5–6% to around 3.5%, reflecting an optimistic inflation outlook. If inflation proves higher, ILBs outperform nominal bonds. If it proves lower, investors still secure 5% above inflation. This asymmetric payoff profile provides both upside and downside protection.
Mispriced Credit Risks
The same cannot be said for South Africa’s corporate credit market. Historically, lending to corporates attracted a higher yield than lending to government. Today, some corporates borrow at lower yields than the sovereign.
This is a function of demand and supply. Corporate borrowing has been weak amid subdued growth and limited capital investment. At the same time, demand has surged due to the proliferation of income funds, with too much capital chasing too little paper. Spreads have compressed to levels that no longer compensate for the risk. In some cases, investors are effectively accepting lower yields for higher risk – a distortion that makes little sense.
For disciplined investors, patience is essential. True opportunities tend to emerge only during dislocations, when spreads widen and attractive yields can be locked in on high-quality names. Outside of such periods, caution is warranted.
A Conservative Path Forward
Prudence should guide fixed income portfolios in this environment. Long-duration government bonds remain vulnerable, and corporate credit exposure is best kept limited. Inflation-linked bonds, by contrast, offer stability, inflation protection and strong prospective returns.
With global debt burdens climbing, the era of ultra-low interest rates behind us, and fiscal uncertainty persisting, ILBs stand out as one of the rarest opportunities in fixed income: government-backed, inflation-protected and offering real yields at multi decade highs.
ENDS
