To put it simply, South African government bonds had an extremely strong year in 2024. In 2024, the FTSE/JSE All Bond Index (ALBI) returned 17.2% in rand terms, outperforming the FTSE/JSE All Share Index, which returned 13.4%. The ALBI’s outperformance is more extreme when comparing the SA bond market to its peer bond markets. In US dollar terms1, the ALBI returned 13.2% versus the J.P Morgan GBI-EM Global Core Index at -2.4% for the year.

An extreme underperformer in the emerging market bond arena has been Brazil. Its 2033 local currency bonds lost 16.2% of their value this year, or an even more abysmal 37.6% when measured in US dollar returns. The Brazilian real hit a record low this year as leftist President Luiz Inácio Lula da Silva (Lula) ramped up government spending on welfare while also caving to populist measures like tax breaks for low-income earners.

Brazil’s budget deficit has doubled since Lula took office and is now close to 10% of GDP in a single year, threatening the sustainability of government debt. By contrast, recent changes to the SA government were seen as overwhelmingly positive - pivoting the country away from populism and towards pro-growth policies, market-friendly private sector inclusion and structural reform.

The SA 10-year bond now trades at a yield of 10.3% versus the Brazilian 10-year bond at a 15.4% yield and the US 10-year bond at a 4.6% yield. The SA yield spread differential versus the US at 5.7% is the tightest spread on record in the last six years, which should ideally reflect an enhancement in our creditworthiness versus the US.

This is somewhat difficult to square from a fundamental perspective when one considers that the SA sovereign has outpaced the US government in terms of debt accumulation as a percentage of GDP over that period - in part due to substantially weaker economic growth.

Even if one accepts this phenomenon of a tighter spread, another conundrum is that we are witnessing one of the first times in US history when US long bond yields have in fact risen following the beginning of a rate-cutting cycle. Some of this is undoubtedly due to the differing trajectories of tight monetary policy versus loose fiscal policy.

In addition, what has rattled offshore bond markets are comments like those made most recently by US Federal Reserve (Fed) Chair Jerome Powell at the final Fed meeting of 2024, where he stated that their year-end inflation projection has 'kind of fallen apart'. At the December meeting, Powell acknowledged that inflation has not abated by as much as the Fed had expected and that 'people are still feeling high prices', which limits the scope to cut rates further by a substantial amount.

When thinking about South Africa’s future trajectory for debt accumulation, what has become clear in the final months of 2024 is that the financial year 2025 borrowing requirement was initially underestimated by Treasury. As such, it was revised higher at the September Medium Term Budget Policy Statement to accommodate for further fiscal slippage.

Rand SA government bonds, however, have become sacrosanct in the Budget, and Treasury has shown a strong commitment to not raising the issuance of rand bonds further, given that they do not want to put pressure on their borrowing costs. Instead, Treasury opted to raise US$3.5bn worth of US dollar-denominated Eurobonds in international markets in November 2024. They are also contemplating creative ways to raise more rand debt outside of the formal SA government bond market.

The use of proceeds for this debt would be the infrastructure projects which have historically been repeatedly cut back from the Budget during rounds of fiscal consolidation. In short, these projects are often crowded out by a larger government wage bill and social grant expenditure. Such efforts to raise rand debt outside of the formal SA government bond market architecture could act to curtail a large rise in supply of paper and could provide a shield for bond investors in particular.

One must keep in mind, however, that the ultimate funder being tapped for a larger rand debt requirement remains the SA savings pool, regardless of the format of the debt and, as such, it is questionable how large the untapped pools of local capital are.

In the last quarter, the Fund cut some long bond duration when SA yields were at their lows and reduced short-dated inflation exposure in exchange for some of the 'new' short fixed-rate bonds issued at attractive levels in primary auction. The Fund offers a gross yield of 10.4% against a modified duration of 4.1, versus the ALBI at 10.1% and 5.7.

While it was the wrong call to enter the election period with a low modified duration position, valuations now look somewhat stretched on a fundamental basis, warranting caution in positioning.