Bonds: Buy and hold as the cycle turns
28 Aug, 2023

Sandile Malinga, Co-Head of Multi-Asset at M&G Investments


Bond markets appeared to turn a corner in July, offering investors positive returns both globally and locally as the outlook for inflation continued to improve in many economies across the globe.


This pointed to an approaching (if not immediate) end to central banks’ interest rate hiking cycles, and some analysts noted that US Treasury bond yields may have peaked. This supported bond returns: the Barclays Global Aggregate Bond Index returned around 0.7% (in US$), while South Africa’s All Bond Index delivered approximately 2.3% (in rands).


While we don’t know if inflation or bond yields have definitively peaked, and wouldn’t build investor portfolios according to such forecasts, at M&G Investments we would say that, at their current real yields, certain global bonds offer good value from both a real yield and diversification perspective. In our view, based on the current roughly 4%-4.5% yield from US Treasuries, investors are being well compensated for any negative surprises from future inflation, and market pricing is broadly aligned with the US Federal Reserve’s view of the interest rate path going forward.


As such, we are holding 30-year US Treasuries and some 30-year UK gilts in many of our global portfolios. In addition, we like a diversified basket of emerging market government bonds, where debt levels are healthy, growth potential is stronger, and currency weakness represents further potential added value as the global interest rate cycle turns.


Meanwhile, South African bonds received a boost from several factors in July, including the SA Reserve Bank’s surprise decision to leave interest rates on hold at its 20 July Monetary Policy Committee meeting, and a sharp drop in consumer inflation to 5.4% y/y in June from 6.3% y/y in May largely on the back of softer food inflation.


Although chances are good for another rate hike in September (given the SARB’s determination to see CPI return to below the 4.5% mid-point of its targeted 3%-6% range and a move higher in Q2 SA inflation expectations), most still see the SARB also nearing the end of its own hiking cycle after a cumulative 475bps of increases since November 2021.


Despite the gains for the month, SA bond valuations remain particularly attractive: with a nominal yield of nearly 11% (real yield of over 5.5%), the 10-year government bond is offering equity-like returns at a lower risk than equities. Such high yields mean that investors are being generously compensated for any negative surprises from inflation ahead. So investors who look through the short-term negativity and hold onto their bond investments should be well rewarded for their patience as conditions improve.



Pause and then cut?


Looking ahead to the remainder of 2023, market watchers expect there to be a period following the last rate hikes in which global and local interest rates remain on hold as central banks ensure they extinguish any last inflationary pressures from their respective economies. Such a scenario is priced into the US market, for example, with one last 25bp rate hike pencilled in for September and then a pause until February 2024. Yet this “status quo” still leaves open the possibility for further bond market recovery over the near-term, particularly if inflation is falling and growth continues to slow, as these conditions are supportive of bonds.


Although volatility is likely to remain high, once central bankers signal that they are comfortable with the inflation outlook and may be considering cutting interest rates, the next stage of the cycle will begin. Falling interest rates and inflation benefit bonds, so that bond holders could be reaping the rewards of a turning cycle over the medium term. While the timing and extent of a new cycle is anyone’s guess, patient investors should be rewarded.





@Sandile Malinga
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