After the sharp back up in yields in March, the bond market rallied in the second quarter of the year. Again, the favourable domestic environment with benign inflation remained the key factor supporting the bond market, while a surprise 50 basis point cut in interest rates in April gave the rally an extra boost. This favourable backdrop was given added impetus by the change in mood in international markets, as concerns of a slowdown in global growth saw international bonds yields fall. This in turn gave rise to an increase in global risk appetite as the search for yield resumed and South African bonds experienced huge demand from offshore investors. The benchmark RSA R153 yield which started the quarter at 8.20% traded down 63 basis points to end June at 7.57%. The shape of the yield curve was largely unchanged with yields moving down in a parallel fashion, except for the very long end, which only managed to rally 30 basis points versus the 60 basis points seen on the yield curve as a whole.

While we remained largely positive on domestic fundamentals throughout the quarter, we also kept our cautious bias on global markets. We maintained our defensive position on our bond portfolios, with duration fluctuating between neutral and underweight throughout the quarter.

With our cautious stance on the bond market, our bond portfolio duration moved between being almost neutral and short duration throughout the quarter, as we actively managed risk and the trading range. This meant that we outperformed the index over the quarter.

Other than the crucial duration decision, bullet-barbell and slope strategies have added to performance. In particular, bullet-barbell strategies that took advantage of the humpedness of the curve added extra performance to the portfolio, as has continued active trading. We expect domestic growth to be robust this year, but with inflation remaining well contained and official interest rates remaining on hold. We still remain cautious about the size of the current account deficit, despite it being easily financed at present, and continue to see this posing a risk to interest rates in the future. With our forecasts for global yields to rise modestly towards the end of the year, we expect to see some upward pressure on domestic yields.

Although the market is very close to fair value at current levels, we see the fair value yield rising gradually from here in the coming months. As a result we are maintaining an underweight duration position in our bond portfolios, but will look to trade the range.

The bond market rallied again during the month of October, and the benchmark RSA R153 traded down to make another all time low in yield at 8.43% during the month. Inflation continued to surprise on the downside, with September CPIX coming in unchanged from the August low of 3.7% year-on-year. Although inflation is expected to start to rise from these levels, it will still remain comfortably within the Reserve Bank's target range for the next 12 months. The benign inflation environment should continue to provide support to the bond market, and we expect interest rates to be on hold for the next year. The Rand also strengthened during October, firming to around 6.10 to the US Dollar buoyed by good news on the sovereign ratings front and positive investor sentiment. The yield curve flattening that started in September continued into October and longer dated bonds again outperformed the short dated bonds.

Although the current account remains a source of some concern, we only expect this to result in a modest depreciation of the Rand. The global environment however, is more uncertain, and the risks remain that global rates rise and exert some pressure on the local market. As these risks balance against the positive domestic backdrop, we expect the bond market to range trade for the remainder of the year.