Rates rose across the yield curve and a steepening of the yield curve took place. Notwithstanding the rise, the benchmark All Bond Index (ALBI) was still able to have a positive return of 1.10%. As a result of the medium term rates increasing more than the other parts of the yield curve, the 3-7 year area was the worst performer (0.87%), the 12+ area was slightly better (0.92%). The best performing area of the yield curve was the 7-12 year area (1.49%), followed closely by the 1-3 year area (1.23%). The cash portion of the benchmark, as represented by the STeFI composite index, performed the best with a return of 1.67%.

Global events dominated markets with the devastation caused by hurricanes Katrina and Rita. The spike in the oil price resulted in concerns that the higher oil price would negatively impact on growth. This was followed by concerns that it would work its way through into higher inflation. Over the quarter the Brent oil price rose to US$63.80 per barrel and US 10-year bond yields rose to 4.29%.

The rand strengthened to R$6.33. Weaker than expected inflation numbers resulted in our bond rates, as represented by the benchmark R153 SA government bond (2010), rising to 7.855%. Growth remained robust and money supply and credit extension numbers continued to be higher than expected. Monetary policy remained unchanged at the August Reserve Bank Monetary Policy Committee meeting, with the Governor raising concerns over the impact of the higher oil prices and its potential inflationary implications. On the fiscal front revenue has continued to surprise on the upside.

Foreigners, who had been net buyers of R12 billion South African bonds during the previous quarter, were net sellers of R11.2 billion over the past quarter, which would also have put upward pressure on our bond rates.

The corporate market was fairly busy. We had five fixed-rate long-term issues that raised R6.15 billion and five floating-rate securitised issues that raised R5.8 billion.

On the money market front the longer term rates rose, while the shorter-term rates remained largely unchanged. The 12-month NCD rates increased to 7.30% and the 3-month NCD rates remained at 6.85%.

The bond exposure was increased to 56%. As a consequence, the weighted duration of the fund increased to 1.78 years. This compares to the duration of the benchmark (60% STeFI and 40% ALBI) of 2.03 years.

It was another volatile month with rates moving up across all maturities. The shape of the yield curve remained largely unchanged. This resulted in the benchmark All Bond Index (ALBI) generating a marginally positive return of 0.02%. The best performing area of the yield curve was the 1-3 year area with a return 0.31%. The 3-7 and 7-12 year areas had fairly similar returns with 0.03% and 0.02%, respectively. The worst performing area was the 12+ area with a return of -0.30%. The cash portion of the benchmark, as represented by the STeFI Composite Index, had a return over the month of 0.57%.
The month started with the news that S&P, the international ratings agency, had upgraded South Africa from BBB to BBB+. As this was the second rating agency to have upgraded South Africa to BBB+, Moody's having done so earlier this year, this was taken positively by the market, as South Africa now came on to the radar screen of a broader group of international investors. Local rates declined on the back of this news.
As the month progressed the market weakened from the lower levels on the back of the higher oil price and, at least initially, weaker US bond rates. Towards the middle of the month the market weakened further on the back of an unchanged Repo rate from the Reserve Bank's MPC meeting, citing concerns over the oil price. Near the end of the month there was further weakening on the back of strong GDP figures, coming in at 4.5%, which was higher than the expected 4.4% and up from the previous month's 4.2%. This was followed by a higher than expected CPIX that came in at 4.2% which was higher than the expected 3.9% and up from 3.5% the previous month; PPI that came in at 3.6% versus the expected 3.3% and up from 2.3%; M3 up from 17.05% to 19.80% and PSCE up from 22.50% to 23.48% over the month. The news that Fitch, the third international rating agency, had also upgraded South Africa to BBB+ was largely ignored.
On the last day of the month news of the devastation that had been caused by hurricane Katrina in the southern US started filtering through. The oil price spiked further and the US dollar came under pressure. In addition, weaker economic data came through from the US, which resulted in US bonds strengthening. The local bond market made up some of the lost ground over that day.
Over the month the rand strengthened from R$6.55 to R$6.39, the benchmark R153 (2010) government bond increased from 7.56% to 7.72%, the US long bonds declined from 4.26% to 4.01% and the Brent crude oil price increased from $58.37 per barrel to $66.93 per barrel.
On the corporate bond issuance front, Absa issued a new R1.5 billionsubordinated seven-year issue off its new AA rating at a spread of 63 basis points above its government benchmark. Edgars issued a further R840 million securitised debt and Inca issued R200 million short-term floating rate debt.
In the money market, the 12-month rate increased from 7.05% to 7.20% over the month, in line with the bond market, and the 3-month rate remained unchanged at 6.90%.
The rising interest rates over the month resulted in the market becoming somewhat cheaper and as a result we increased our exposure to the bond market. The weighted duration of the fund increased from 1.24 years to 1.46 years over the month. This compares to the duration of the benchmark (60% STeFI and 40% ALBI) of 2.18 years.
The very high oil price is likely to keep the inflation target under pressure. Consequently, we do not believe there remains scope for the Reserve Bank to cut interest rates any further. The bond market has become more expensive again and we are likely to wait for some weakness to emerge before increasing the duration of the portfolio any further.

The market volatility remained a feature. During the earlier part of the month, the rand weakened and interest rates rose. By the end of the month the rand strengthened and rates declined. The rand strengthened to R$6.55 and the benchmark R153 (2010) government bond declined to 7.55%. The major support for the stronger bond market came from better than expected CPI and PPI numbers. The CPIX came in at 3.5% versus the expected 3.8% and PPI came in at 2.3% versus the expected 2.4%.
Local bond market strength came, despite a meaningful weakening in the US long bonds with the 10-year bond rising to 4.26%. In addition, the Brent oil price rose to $58.37 per barrel. We continued to see very high money supply numbers - up to 17.05% (M3), and even though the credit extension numbers were slightly down to 21.89%, they remain very high.
In the money market we had a bit of a mixed picture with the 12- month rate decreasing to 7.05% and the 3-month rate increasing to 6.90%.
The bond market pricing became very expensive as a result of our declining rates and US rates rising. We therefore kept our exposure very short. 47% of the fund is exposed to the bond market and 53% to the money market. The weighted duration of the fund is 1.24 years compared to the benchmark duration (60% STeFI and 40% ALBI) of 2.11 years.
The Reserve Bank's next Monetary Policy Committee meeting is scheduled for the second week of August. Against a backdrop of very benign inflation and an improved credit rating from Standard & Poor's there remains the possibility of a further Repo rate reduction. This however, is not our base case. We believe that the Reserve Bank has done enough, and to reduce the rate further would stimulate an economy that is already growing fairly strongly.
The bond market has once again become very expensive and at these lower levels we are inclined to maintain a short duration position in anticipation of a retracement of the bond rates to higher levels.

What has been supportive of our bond market has been the fact that over the quarter the inflation outlook has also improved, notwithstanding the depreciating rand and rising oil prices. Over this period the oil price has risen from US$52.72 to US$56.52 per barrel. While CPIX has been rising slowly the outcome has been below market expectations. Forecasts have also indicated that the outcome is likely to remain comfortably within the Reserve Bank's target range over the forecast period. A major supportive factor has been the very benign food inflation numbers.
Foreigners have also been attracted to our market by our relatively high interest rates and have been net buyers of South African bonds to the value of R12 billion over the quarter, putting further downward pressure on our rates.
On the money market front the Reserve Bank surprised the market in April by reducing the Repo rate by 50 basis points. This was against the background of a depreciating rand, rising oil prices and very high credit extension and money supply growth numbers.
With the improvement in the valuations of the bond market we have increased our exposure to the bond market, with a resultant increase in the weighted duration of the portfolio. 46% of the fund is now exposed to the bond market and 54% to the money market. The weighted duration of the fund is 1.27 years. This compares to the duration of the benchmark (60% STeFI and 40% ALBI) of 2.14 years.
Even after interest rates had risen sharply in March we were still of the view that the bond market was very expensive. What has happened since then is that US interest rates, that form the base of our fair value models, have declined to such an extent that our yield curve in general has become less expensive and certain areas along the yield curve are now offering some value.
The more benign inflation outlook has also worked its way into our views and has led us to believe that the Reserve Bank is unlikely to be raising interest rates in the near future. In fact, with the economy showing some signs of slower growth, it is not beyond the bounds of possibilities that the Reserve Bank could cut interest rates further. This is not however our base case.
On the back of the above views we will selectively be increasing the duration of both our bond and money market portfolios over the period ahead.

The bond market continued its roller coaster ride of the past few months. On the back of the rand weakness, interest rates rose and we had a further steepening of the yield curve. The benchmark All Bond Index (ALBI) returned -0.12%, while the 1-3 year area, the best performing area of the yield curve, returned 0.41%. The 3-7 year area had a positive return (0.18%), while the 7-12 area (-0.16%) and 12+ area (-1.20%) had negative returns. The cash portion of the benchmark, as represented by the STeFI composite index returned 0.59%.
The weakening rand was the major feature during the month. This coincidentally came after the authorities had been calling for a more competitive rand. The driving force behind the rand weakness was the strength of the US dollar against the Euro. Looking at the historical relationship between the rand and our bond rates one would have expected bond rates to go up as well. This did not happen to the extent that may have been expected, primarily because the US long bonds declined to 4.07%, acting as a brake to local bonds. The Brent crude oil price also declined to $50.50.
CPIX came in better (3.8%), while PPI came out worse than expected (1.8%). The money supply and credit extension numbers also came out much stronger than expectations and meaningfully up from the previous figures. These events resulted in bond market volatility and a yield curve steepening. The benchmark R153 (2010) government bond rose to 7.99%. With interest rates rising and the yield curve steepening, the shorter end of the bond yield curve outperformed the longer end, benefiting the portfolio positioning.
On the corporate bond issuance front Unitrans and Standard Bank came out with fixed rate issues. In the money market we had a mixed picture with the 12-month rate increasing to 7.15% and the 3-month rate remaining 6.85%.
We kept our exposure very short - 47% of the fund is exposed to the short end of the bond market and 53% to the money market. The weighted duration of the fund is 1.01 years, which compares to the benchmark (60% STeFI and 40% ALBI) duration of 2.15 years.
While there remains an outside chance of the Reserve Bank further reducing the Repo rate, it is not our base case. With inflation having bottomed, the money supply and credit extension numbers continuing to show very strong growth, and a weakening rand, we believe it would be imprudent to have any further easing of monetary policy. We believe we are at the bottom of the interest rate cycle and the next move in money market rates is likely to be up, albeit only next year.
Concerns about a slowing down of the global economy and reduced inflation fears are beginning to work their way into global and local bond rates. These issues are closely monitored as it could influence our view on the market going forward.

The bond market rebounded after March's weakness, following the South African Reserve Bank's (SARB) surprise Repo rate cut. Yields generally declined and we had a further steepening of the yield curve. The benchmark All Bond Index (ALBI) returned 2.06% and the cash portion of the benchmark, as represented by the STeFI composite index, returned 0.57%.
While rates had risen further after the end of March, they dropped sharply after the rate cut. This was supported by a strengthening of the rand to R$6.078 and the US long bonds declining to 4.202%. The Brent oil price remained largely unchanged at the $52 level. CPIX surprised the market by being slightly higher than expected at 3.6%. There was also a slightly negative surprise with the PPI numbers, which came out at 1.9%.
These moves resulted in the R153 (2010) benchmark government bond declining to 7.855% and the R152 (2006) government bond to 6.90%. Money market rates declined across the curve - 12-month NCD rates moved down to 7.00% and 3-month NCD rates to 6.85%.
It was a fairly active month on the corporate bond issuance front. BMW had a number of securitised floating rate issues to the value of R850 million. Trans Caledon Tunnel Authority had five fixed rate government guaranteed issues, with maturities ranging from 10 to 16 years to the value of R500 million. Telkom had a tap issue of their TL06 (2006) bond to the value of R600 million. Standard Bank had a three-year senior debt fixed rate issue to the value of R1.5 billion. The last issue was a R700 million fixed rate eight-year bond, issued by the City of Johannesburg.
On the back of our view that the market remains very expensive, we kept our exposure very short. The fund is 31% exposed to the bond market and 69% to the money market. The weighted duration of the fund is 1.05 years compared to the benchmark (60% STeFI and 40% ALBI) duration of 2.15 years.
The market was thrown into disarray by the Reserve Bank's surprise Repo rate cut. Whereas we were previously fairly confident that there would be no further rate cuts, now there is a risk that they can do so again. Our interpretation of the economic fundamentals is that we believe we have seen the bottom in the inflation cycle and it should gradually move up. On the back of this we believe the SARB should, over the next twelve months, be raising rates to ensure that we remain within the inflation target range. In anticipation of an interest rate cycle that should start moving up over the next twelve months, we will be keeping the portfolio fairly short.

The year 2005 started off very well for the bond market, but during March it gave up all the ground it had made. We also had a steepening of the yield curve as rates rose across the board. As a result the benchmark All Bond Index (ALBI) had a negative return of 0.33%. The worst hit area of the yield curve was the long-end with the 12+ area returning -1.72%. The 7-12 year area returned -0.76%, the 3-7 year area a positive 0.15% and the shortend 1-3 year area a positive 0.24%. The cash portion of the benchmark, as represented by the STeFI composite Index, had the best return of 1.79%.
After a bull run in the bond market since June 2004, the market finally blinked at the beginning of March. Over that period the market was driven by the strong rand and its positive impact on inflation. The market largely ignored the strong economic growth, money supply and credit extension. An expectation that the US was likely to raise their policy rates more rapidly than expected refocused the market. This worked its way through to rising US bond rates and a strengthening of the US Dollar. At the same time, the oil price rose to US$52, and the rand depreciated to R$6.23. Prior to these events the local market had been expecting a further Repo rate cut, but now the pervading view is that we have reached the bottom of the local interest rate cycle.
On the back of our view that the market was very expensive, we kept our exposure very short. The fund is 31% exposed to the bond market and 69% to the money market, with the fund's weighted duration at 1.10 years. This compares to the duration of the benchmark (60% STeFI and 40% ALBI) of 2.17 years.
The mood of the market has certainly changed. While bond market rates have already moved up quite considerably, this largely reflects movements in the underlying building blocks - like the US bond rates and the country risk premium - as reflected by the spread between the US rates and the South African bonds issued in US Dollars. The compensation for the risk of being in South African bonds is still very low by historical standards, and as such the bond market remains expensive.
On the money market front we do not expect any further Repo rate cuts, but equally we do not see the Reserve Bank hiking those rates for the balance of this year. We could however, see money market rates moving up over the next six months in anticipation of a hike in the Repo rate next year.
In anticipation of further rises in interest rates over the balance of the year, we are likely to keep the portfolio fairly short.

The fixed income market continued the good performance achieved in the 3rd quarter. Interest rates across the yield curve declined and the yield curve flattened even further. As a result of the declining interest rates, the benchmark All Bond Index (ALBI) had a very good return of 7.67%. The best performing area of the yield curve was the long end with the 12+ area having a return of 13.34%. The 7-12 year area returned 10.60% and the 3-7 year area 5.77%. The worst performing area was the short-end 1-3 year area with 2.53%. The cash portion of the benchmark, as represented by the STeFI composite index, returned 1.87%.
Over the quarter, we have seen a dramatic decline in interest rates, notwithstanding a rising trend in both CPIX and PPI, and negative surprises relative to consensus forecasts in these numbers. This has largely been driven by the continued rand strength (from ZAR/USD6.48 to ZAR/USD5.64), supported by the Brent oil price declining to USD39.90 over the same period. Together with benign food prices, this led to a reduction in inflation expectations going forward.
These events had the effect of reducing the R153 (2010) benchmark government bond rate to 7.82% and the R152 (2006) bond rate to 6.97%, notwithstanding a rise in the United States 10-year government bond rate to 4.32%.
The Reserve Bank left the repo rate unchanged at both the October and December Monetary Policy Committee meetings, largely as a result of the very high money supply and credit extension numbers.
The money market was a bit of a mixed picture - the 12-month NCD rates declined in line with the bond market rates (moving to 7.35%), while the 3- month NCD rates actually rose to 7.40% reflecting the markets disappointment that the Reserve Bank did not reduce the official rates further.
With the market strength the bond market has become very expensive, notwithstanding the improved inflation outlook. As a result, the portfolio's bond market exposure was reduced to 32% with the balance in the money market. This has reduced the weighted duration of the fund to 1.16 years.
The rand strength has been a major positive for inflation and therefore the future path of monetary policy. The Reserve Bank has to balance this positive with the potential inflationary risks inherent in a strongly growing economy - to a large extent driven by consumer demand. Further interest rate cuts could fuel this demand with major negative implications for the Reserve Bank's inflation target over time. While the possibility of further cuts in interest rates in 2005 is not all that remote, we believe that the risks would be too high for the Reserve Bank and therefore have taken the view that the Repo rate will remain unchanged for the bulk of 2005.

It was another very good month for bonds with interest rates declining meaningfully across the yield curve, particularly at the longer end. This resulted in a further flattening of the yield curve and the longer bonds outperforming the shorter bonds. The benchmark All Bond Index (ALBI) returned 2.25%, and the 12+ area (the best performer) 3.83%. The 7-12 year area returned 2.93%, the 3-7 year area 1.73%, and the 1-3 year area (the worst performer) 0.85%. The money market portion of the benchmark, as represented by the STeFI Composite Index, returned 0.60%.
The ongoing rand strength has been the main driver of the ongoing decline in interest rates. The rand strengthened from to R$5.78, reaching levels last seen in 1998. This has driven the interest rate market to historic lows on the back of a very benign inflation outlook. It has also been supported by the Brent crude oil price declining to US$45.43 over the period.
The rand strength overshadowed other factors that emerged that would under normal circumstances have had a negative impact on the direction of interest rates. These include the US 10 year bond that rose to 4.36%, CPIX and PPI numbers that surprised the market on the negative side, money supply and private sector credit extension numbers that are very high, and very strong third quarter GDP growth.
The corporate bond market had a flurry of activity in the run-up to the yearend. Standard Bank came to the market with two issues. The first was a R2bn seven-year subordinated debt issue at a spread of 95 basis points above the R157 and the second, a R3 bn six-year senior debt issue at a spread of 65 basis points above the R153. The Trans Caledon Tunnel Authority (government guaranteed) issued a R600m four-year bond at a spread of 30.5 basis points above the R194. A series of R1.2 bn floating rate notes was also issued by BMW at spreads ranging from 15 to 35 basis points above the three-month Jibar rate.
On the money market front the three-month NCD rate remained unchanged at 7.35%, while the 12-month NCD rate declined, in line with bond market rates, to 7.25% as expectations rose of further repo rate cuts.
As a result of this fund merging with the Nedbank Income Fund, the bond/ money market split has changed somewhat, but the modified duration of the fund remained largely unchanged at 1.17 years. Currently, the fund has a 32% exposure to bonds and 68% to money market instruments.
The strong rand has been the main driver behind the positive inflation outlook, which in turn, dragged interest rates lower. In the process, the bond market has become extremely expensive when looking at our fair value models. For that reason we are comfortable to remain underexposed to the bond market relative to our benchmark.