Bonds had a very good month 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 2.17%, the 12+ area (the best performer) 3.51%, the 7-12 year area 3.04% and the 3- 7 year area 1.73%. The worst performer was the 1-3 year area with 0.77%.
While a few negatives emerged for the bond market, these were overshadowed by a number of fairly significant positive events. The negatives were a continuation of the rise in the Brent crude oil price to US$48.92 and a continuation of the very high money supply and credit extension numbers. Also, the Reserve Bank left the Repo rate unchanged.
The major positive for the bond market remained the ongoing rand strength (from R$6.48 to R$6.14). A major driver of the rand strength was the positive ratings watch announcements on South Africa's credit rating from Moody's and Fitch. The rand strength continued its positive impact on inflation numbers. Both CPIX and PPI again positively surprised the market. CPIX came out at 3.7% (unchanged from the previous month). PPI came out at 1.4% (up from the previous level of 1.1%). While the oil price has been seen as negative for inflation, it is also seen as a threat to global growth with positive consequences for US bonds. The US 10 year bond declined from 4.12% to 4.06%. The result of these factors is that the benchmark R153 (2010) government bond declined from 8.81% to 8.47% before closing at 8.52%. The shorter R152 (2006) government bond declined to 7.445%.
The corporate bond market was fairly quiet with the only new issue being the securitisation of R800 million primary mortgages over a range of commercial properties by Pangbourne and iFour. While a range of notes was issued, they were all floating rate notes. A
fter an earlier expectation of another Repo rate cut, money market rates increased when it did not materialize. The 12-month NCD rate increased to 7.60% and the 3-month NCD rate increased to 7.35%.
The portfolio has remained overweight the shorter end of the yield curve and underweight the very long end.
The longer the rand remains at current levels the better the outlook for inflation, and this will drive the future direction of bond rates. Our base case, however, is still premised on a deteriorating inflation outcome on the back of an economy that is growing strongly.

This quarter saw a reversal of the previous six months. Interest rates across the yield curve declined and a flattening of the yield curve took place. As a result of the declining interest rates the benchmark All Bond Index (ALBI) had a very good return of 6.90% over the quarter. The best performing area of the yield curve was the long end with the 12+ area returning 9.31%. The 7-12 year area returned 7.73%, the 3-7 year area 6.51% and the short-end 1-3 year area (the worst performer) 4.22%.
While consumer inflation trended higher over the first half of this year, it fell back sharply in July and August on base effects and lower petrol prices. This was further supported by continued rand strength and subdued food prices. CPIX fell to its lowest reading on record at 3.7% in August. This was sufficient for the Reserve Bank's Monetary Policy Committee (MPC) to surprise the market by reducing the repo rate 7.5%. A deteriorating factor has been the oil price, with Brent spot increasing to USD46.22 per barrel.
These events brought down the R153 (2010) benchmark government bond rate to 8.81%. Similarly, the R152 (2006) bond rate declined to 7.56%. Over that period we had the United States 10- year government bond rate declining to 4.12%, lending further support to our market.
The corporate bond market was fairly active with the issuance of R1bn A- rated African Bank bonds and R1.5bn AA- rated Barloworld bonds. Since then the only other issue was R0.1bn A+ rated Inca subordinated bonds.
Money market rates reacted very sharply to the surprise repo rate cut. The 12-month NCD rate declined to 7.50%, while the 3-month NCD rate declined to 7.15%.
The portfolio remained overweight the 1-3 and 3-7 year areas of the yield curve and particularly underweight the 12+ area. As a result, the modified duration of the portfolio is considerably lower than that of the ALBI.
After the Reserve Bank's surprise repo rate cut, they very recently sounded some notes of caution on the back of the rising oil price and rampant consumer demand. We believe further cuts in the Repo rate unlikely in the months ahead. The cut in August probably hastened the timing of the first rise in the interest rate cycle. As a result, it is likely that the market will start to anticipate these rises, which will be negative for the bond market. We are therefore likely to retain our shorter duration position in the fund.

The bond market performed very well over the month as a result of interest rates declining meaningfully across the yield curve. Even though the yield curve steepened fairly dramatically, the magnitude of the move was such that the longer dated bonds were the best performers. The benchmark All Bond Index (ALBI) returned 3.51%, the 12+ area (best performer) 3.99%, the 7-12 year area 3.84%, the 3-7 year area 3.54% and the 1-3 year area 2.02%.
The major market-moving event over the month was the surprise 0.50% Repo rate reduction by the Reserve Bank. This reduction came on the back of a rand that had surprised most analysts by its persistent strength, which resulted in inflation being a lot more muted than expected. The July CPIx inflation number came out at 4.2%, which was slightly lower than the expected 4.3% and down from the previous month's 5.0%. PPI came out at 0.7%, also lower than the expected 1.3%. The rand fell sharply on the back of the Repo rate cut - the rand declined from R$6.27 to R$6.64. The bond market rallied aggressively on the news, with the R153 (2010) declining from 9.58% to 8.80%. The shorter dated R152 (2006) declined even more meaningfully from 8.56% to 7.56%.
The corporate bond market was quiet over the month with no new borrowers coming to the market.
Money market rates also declined sharply on the back of the Repo rate cut, with the 12-month NCD rate declining from 8.55% to 7.75% and the 3-month NCD rate declining from 8.00% to 7.30%.
The portfolio remained overweight the shorter end of the yield curve and underweight the very long end.
The longer the rand remains at current levels the better the outlook for inflation, which is what will drive the future direction of interest rates. With the more relaxed monetary policy stance that the Reserve Bank appears to be taking, there could be scope for another interest rate cut at the next Monetary Policy Committee meeting. Our base case is still premised on a deteriorating inflation outcome on the back of an economy that is growing pretty strongly. In the event that the rand remains at current levels, we may need to review the portfolio structure.

Nedcor Retail Investments proposes on the 1 Nov 04, to amalgamate the Nedbank Gilt Fund with the Nedbank Bond Fund, and will be managed by Herman Steyn and Guy Toms of Prescient Investment Management according to the investment policy of the Nedbank Bond Fund.

Interest rates were fairly volatile over the quarter, and the yield curve also steepened further. Notwithstanding the continued rising interest rate trends, the benchmark All Bond Index (ALBI) returned 0.44%. The 1-3 year area was the best performer (1.70%) and the 12+ year area the worst performer (-1.62%). The 3-7 year area returned 1.10% and the 7-12 year area -0.52%.
The Reserve Bank's Monetary Policy Committee (MPC) left interest rates unchanged in April, yet warned of inflation risks emanating from oil and food prices. The Brent crude price rose to a high of USD38.79 per barrel. At the June MPC meeting those concerns had largely abated, with Brent crude down to USD 33.45 and good rains, supported by a rampant rand, taking the edge off food inflation. The rand, ended the quarter at R/USD6.16 down from a high of R/USD6.93, and inflation came out lower than expected.
This volatility worked its way through to bond rates as illustrated by the R153 (2010), which started the quarter at 9.52%, rose to 10.24% and ended at 9.87%. The US long bond rates (10 year) rose from 3.85% and ended at 4.59%.
The corporate bond market had probably its busiest quarter in its history, with the issuance of almost R7.5 billion - R2.9 billion in fixed rate vanilla bonds, R4.3 billion in floating rate securitised bonds and R0.25 billion in floating rate commercial paper.
The money market was quiet but had an upward bias in the longer end. The 3-month NCD rate remained unchanged (8.00%) and the 12-month NCD rate moved up (8.90%).
The portfolio remained overweight the 1-3 and 3-7 year areas of the yield curve and particularly underweight the 12+ area. As a result, the modified duration of the portfolio is considerably lower than that of the ALBI.
After six months of rising interest rates on the back of an expectation of rising inflation, the market is now questioning the future. On the back of a strong rand and benign food inflation, inflation forecasts are being pared back. This is resulting in the timing of a Repo rate rise being pushed out, and to levels not as high as previously expected. The rand remains the wild card - if it continues to strengthen inflation will be lower than expected, which would be good for the bond market. Against this, South Africa has a strongly growing economy that would normally put interest rates under upward pressure.

The yield curve flattened dramatically in December, after a smaller than expected cut in the Repo rate. Over the quarter the benchmark All Bond index (ALBI) had a total return of 2.8%. The 7-12 year area was the best performing area with a return of 3.7% and the 1-3 year area the worst, with a return of 2.4%. The fund is overweight the 3-7 year area and underweight the 12+ area, with a modified duration shorter than the ALBI benchmark.

Interest rate markets have been driven by Reserve Bank actions, and more specifically the market's expectations of their actions. With the Reserve Bank acting more aggressively than expected, the market, and in particular the short end of the market, came down aggressively. During this period the fund had a rapid normalisation of the yield curve.

In contrast, during December, the fund had a substantial flattening of the yield curve. The short end moved up dramatically after the Reserve Bank reduced the Repo rate by only 50 basis points against market expectations of a cut of between 100 and 200 basis points. Over December the R150 (2005) bond rate rose by 82 basis points and the R153 (2010) by 19.5 basis points, while the R186 (2026) declined by 17.5 basis points.

Money market rates responded in a similar fashion. They declined rapidly over the first two months of the quarter and then rose after the disappointment of the smaller than expected Repo rate cut. The 3-month and 12-month NCD rates reached lows of 7.5% and 7.35% respectively, before moving up to 7.95% at the end of December.

Fundamentals of the interest rate market show signs of a nearing end to the bull market. While the December CPIX and PPI numbers were in line with expectations, they are nearing the bottom of their cycle. Unless the rand continues to strengthen, all indications are that inflation should start trending up over the next three to six months. Money supply and credit growth numbers have been higher than expected, and this should ring a warning bell for the Reserve Bank to be very wary of further cuts to the Repo rate. On the back of the very strong rand, imports grew rapidly and exports declined - putting potential constraints on the Balance of Payments. The fund manager's believe the probability of further interest rate cuts have diminished meaningfully and the fund manager's are likely to continue investing in the shorter end of the yield curve.