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South Africa’s new government triggers a rush on local bonds

South Africa’s new government triggers a rush on local bonds

(Bloomberg) — Demand for South African local currency bonds is soaring, fueled by optimism about the country’s new broad coalition government and the prospect of interest rate cuts as inflation eases.

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Barely halfway through the year, net purchases of these debt securities by foreigners already exceed the total for all of 2023. Demand has risen since the African National Congress (ANC) invited rival parties to help govern the country after it lost its parliamentary majority in the May 29 elections.

The bonds have returned 8.5 percent in dollar terms since the vote, by far the best performance in a Bloomberg index of local government bonds from emerging markets. Turkey had the second-best return at 3.9 percent, while the average is 0.5 percent.

“South African government bonds have experienced a remarkable rally in the wake of the election, outperforming all other local emerging markets,” said Christian Wietoska, strategist at Deutsche Bank AG.

Investors are betting that the presence of opposition parties could help the new government address the state’s inability to tackle power shortages and logistical problems that are holding back economic growth. The rand has been the best-performing developing world currency since the election, and South African stocks have hit record highs.

Foreign nationals have bought 12.2 billion rand ($670 million) worth of South African bonds since May 29, according to trade data from stock exchange operator JSE Ltd. That brings year-to-date inflows to 22.2 billion rand, surpassing the 16.5 billion rand seen last year.

A sharp rise in orders at South Africa’s weekly bond auctions is further evidence of strong demand from both foreign and domestic investors. The latest auction on Tuesday attracted orders worth R11.5 billion, more than three times the R3.75 billion worth of securities on offer, central bank data showed. That’s the strongest demand in three weeks.

The yield on South Africa’s 10-year bonds remained almost unchanged at 11.04% at 12:35 p.m. in Johannesburg, about the lowest level since February 2023.

Farzana Bayat, fixed income portfolio manager at Foord Asset Management in Cape Town, said the rally in South African bonds had reduced yields by more than 100 basis points since the election. The worst-case scenarios feared by investors – such as a radical political shift to the left – had been avoided, she said.

According to Bayat, this is also reflected in the lower costs of hedging against a South African default by purchasing credit default swaps.

“The market is expecting a lower country risk premium for bonds, which is reflected in CDS, which have increased from 370 to 300 basis points,” she said.

Meanwhile, inflation expectations for the next two years have declined, indicating progress in the central bank’s efforts to contain it. Average inflation expectations for the next two years – which the South African Reserve Bank uses to base its decisions – fell to 4.9% in the second quarter from 5.2%, according to a survey released on July 5.

The strong price gains already achieved by bonds suggest that their potential for further increases may be somewhat dampened, says Wietoska of Deutsche Bank.

“Overall, we believe there is a structural change in South Africa,” he noted. “Nevertheless, we are moving from overweight to moderate overweight due to the higher valuation.”

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