Nedbank Bond comment - Sep 05 - Fund Manager Comment25 Oct 2005
The 3-7 year sector and the 12+ sector underperformed the ALBI return of 1.10%. The rand strengthened on the back of rising commodity prices, to end the quarter at R6.32/USD and R7.60/Euro respectively. The dollar was resilient despite the effects of the hurricane disasters.
US treasuries had a poor quarter after the previous quarter's strong performance. The US ten-year bond rose 35 basis points to end at 4.29%. The Fed continued with its policy of a 25 basis point rate hike at each FOMC meeting, hiking rates twice over the quarter to 3.75%. A robust US economy and inflationary pressure, caused by the high oil price, should see the Fed continue to hike.
The fund had significant exposure to inflation-linked bonds at the long end of the curve. We maintained the positions as we felt that inflationlinked bonds continued to offer some value relative to fixed-coupon bonds. With a current implied inflation of 4.92% discounted in the R186, one must believe that inflation will be below 4.92% over the long term in order to see value in the R186 fixed-rate bond. We still maintain that good news is priced into these bonds, and that the inflation-linkers still offer some value. The 8-12 year area of the curve, with implied inflation around 5.4% offers better value.
The fund is exposed to the R194, R153 and R157 areas of the yield curve, while exposure in the longer dated R186 area has been switched to inflation-linked bonds. The fund's nominal duration is around 0.26 years higher than the All Bond index. The effective duration excluding the duration of inflation linkers is around 1.30 years lower than the ALBI.
While we are comfortable with the inflation scenario, we believe that the difference between nominal and real yields (ie, implied inflation) can widen as the higher oil prices starts coming through in the inflation numbers.
Risks to be monitored over the course of the year include:
- A continued deterioration of the current account.
- Rising US yields.
- Consumer spending and credit growth.
- The potential second-round inflationary impact from higher oil prices.
Nedbank Bond comment - Aug 05 - Fund Manager Comment26 Sep 2005
Bonds performed poorly as a result of worse than expected inflation and rising oil prices. Bond yields shifted up about 15-20 basis points out to ten years, with the long end performing poorly as the R186's rose 21 basis points to 7,69%. The 1-3 year was the best performer (+0.31%), and the 12+ year sector was the worst performer (-0.30%).
The rand strengthened, while the dollar was weaker against the major currencies - around 15 cents against the dollar and 4 cents against the Euro - to end at R6,40/USD and R7,86/Euro respectively. US treasuries recovered from the previous month's poor performance as rates fell 25 basis points. The Fed raised rates by 25bp to 3.5%.
The fund had significant exposure to inflation-linked bonds at the long end of the curve - we maintained these positions, as we believe it continued to offer value relative to fixed-coupon bonds. One must believe that inflation will be below 4.26% over the long term in order to see value in the R186 fixed-rate bond. The 8-12 year area of the curve, with implied inflation around 4,86%, offers better value.
The fund is exposed to the R194, R153 and R157 areas of the yield curve, while exposure in the longer dated R186 area has been switched to inflation-linked bonds. As a result, the nominal duration of the fund is around 0.40 years higher than the All Bond Index. The effective duration, excluding the duration of inflation-linkers is around 1.31 years lower than the ALBI.
The bond market performed poorly as rates ticked up across the curve. Inflation data came in above expectations and the surging oil price will continue putting upward pressure on inflation.
Implied inflation has risen to around the 4.20% to 4.85% level. Bond yields ticked up while real yields fell, which meant that the level of implied inflation has risen. Inflation-linked bonds were the best performing asset class delivering 2.06% as R198, R189 and R197 yields fell by more than 20bp.
While we are comfortable with the inflation scenario, we still believe that the difference between nominal and real yields (ie, implied inflation) can widen as the higher oil price starts coming through in the inflation numbers.
Risks to be monitored include:
- Further currency weakness that could put upward pressure on domestic prices
- A continued deterioration of the current account
- Rising US yields
- Consumer spending and credit growth
- The surging oil price
We would look to switch out of inflation-linked bonds should implied inflation at the long end increase to levels where fixed-coupon bonds offer value.
Nedbank Bond monthly review - Aug 05 - General Market Analysis21 Sep 2005
Market Review
Bonds performed poorly in August as a result of worse than expected inflation and rising oil prices. Bond yields shifted up about 15-20 basis points out to ten years, with the long end performing poorly as the R186's rose 21 basis points to 7.69%. The 1-3 year was the best performer (+0.31%) for the month. With a return of -0.30%, the 12+ year sector was the worst performer and underperformed the ALBI return of 0.02%.
The rand strengthened slightly in August with the dollar weaker against the major currencies. For the month, the rand strengthened around 15 cents against the dollar and around 4 cents against the Euro, to end the month at R6.40/USD and R7.86/Euro respectively.
US treasuries recovered from the previous month's poor performance as rates fell 25 basis points from 4.26% to 4.01%. As expected, the Fed raised rates by 25bp to 3.5%. With the damages caused by hurricane Katrina and the Fed's comments on the economic situation, there is now talk in the market that the Fed might pause its rate hiking policy.
Portfolio Review
The fund had significant exposure to inflation-linked bonds at the long end of the curve, and we maintained the positions as we felt that inflation linked-bonds continued to offer value relative to fixed-coupon bonds. With a current implied inflation of 4.26% discounted in the R186, one must believe that inflation will be below 4.26% over the long term in order to see value in the R186 fixed-rate bond. We still maintain that a lot of good news is priced into these bonds, and that the inflation-linkers still offer better value. The 8-12 year area of the curve, with implied inflation around 4.86% offers better value.
The fund is exposed to the R194, R153 and R157 areas of the yield curve, while exposure in the longer dated R186 area has been switched to inflation-linked bonds. As a result, the nominal duration of the fund is around 0.40 years higher than the All Bond Index. The effective duration, excluding the duration of inflation-linkers, is around 1.31 years lower than the ALBI.
Market Outlook - Money Market
The Reserve Bank decided not to reduce interest rates in August as economic activity and domestic demand remains robust. While inflation is expected to remain within the target range during the forecast period, the uncertainty surrounding the wage negotiations and the upward pressure on oil prices pose a risk to the inflation outlook.
The Reserve Bank has found itself having to balance the inflationary vs. growth prospects in the economy. With growth picking up significantly in the last month, and with inflation coming out higher that expected, the market is pricing out any further rate cuts.
Market Outlook - Bond Market
The bond market performed poorly in August as rates ticked up across the curve. Inflation data for August came in above expectations and the surging oil price will continue putting upward pressure on inflation.
Implied inflation has risen to around the 4.20% to 4.85% level. Bond yields ticked up in August while real yields fell, which has meant that the level of implied inflation has risen. Inflation-linked bonds were the best performing asset class for the month delivering a return of 2.06% as R198, R189 and R197 yields fell by more than 20bp.
While we are comfortable with the inflation scenario, we still believe that the difference between nominal and real yields (ie, implied inflation) can widen as the higher oil prices starts coming through in the inflation numbers.
Risks to be monitored over the course of the year include:
- Further currency weakness that could put upward pressure on domestic prices;
- A continued deterioration of the current account as local consumers and retailers continue to import "cheap" goods from overseas;
- Rising US yields: US yields moved up significantly this month and they are predicted to move higher as the Fed continues to hike rates. This will put pressure on SA bonds;
- Consumer spending and credit growth. Retail car sales, as well as credit continue to grow at unsustainable levels; and
- The surging oil price.
Implied inflation for the R186 has now moved to just above 4.2%, with no risk premium built in for unexpected inflation. This is up from the implied inflation low of 3.5%, but there is still value in the inflation-linked bonds relative to the fixed-rate bonds. The medium-dated bonds offer more relative value if one believes that inflation in the order of 4.8% is probable.
Portfolio Structure & Strategy
We still see value in inflation-linked bonds, given that fixed-rate bonds are still pricing in a relatively optimistic inflation scenario. We are maintaining our position in inflation-linked bonds at the very long end of the curve, an area where we see value in real yields.
We would look to switch out of inflation-linked bonds should implied inflation at the long end increase to levels where fixed-coupon bonds offer value.
Nedbank Bond comment - Jul 05 - Fund Manager Comment07 Sep 2005
The fund had significant exposure to inflation linked bonds at the long end of the curve, and we maintained the positions as we felt that inflation linked bonds continued to offer value relative to nominal bonds. During the month, implied inflation at the long end moved slightly lower. With a current implied inflation of 4.1% discounted in the R186, one must believe that inflation will be below 4.1% over the long term in order to see value in the R186 fixed-rate bond. We still maintain that a lot of good news is priced into these bonds, and that the inflation-linkers still offer better value. The 8-12 year area of the curve, with implied inflation around 4,5% offers better value.
The fund is exposed to the R194, R153 and R157 areas of the yield curve, while exposure in the longer dated R186 area has been switched to inflation-linked bonds. As a result, the nominal duration of the fund is around 0.35 years higher than the All Bond Index. The effective duration, excluding the duration of inflation-linkers, is around 1,25 years lower than the ALBI.
With the next Monetary Policy Committee meeting scheduled for August, money market rates started to tick downwards as the market began to price in some risk of a cut. With inflation below expectations, and the rand having strengthened from its lows, many believe that there is scope for further rate cuts. Governor Mboweni explained the last rate cut within the need for a competitive exchange rate, and it is assumed that the Reserve Bank will in future look to counter any excessive rand strength with interest rate cuts. With government publicly looking to boost growth above 6%, real rates can be expected to remain low going forward.
The Reserve Bank has found itself having to balance the inflationary vs. growth prospects in the economy. The market is currently pricing in 50% chance of a 50 basis point rate cut in August. With the rand having strengthened in recent weeks, the risk that Governor Mboweni will choose to cut in August has increased significantly.
Nedbank Bond comment - Jun 05 - Fund Manager Comment12 Aug 2005
The rand continued to weaken against the dollar, as the dollar staged a strong recovery and the Reserve Bank surprised the market with an interest rate cut. The rand weakened from R6.22 to R6.65 to the dollar. The dollar strengthened from 1.296 to 1.21 euros as economic sentiment deteriorated in Europe after the collapse of the European constitution. The Reserve Bank surprised the market with a 50 basis point rate cut at the April MPC meeting.
Despite rates having fallen, implied inflation has remained steady and we still see value in inflation-linked bonds relative to nominal bonds. With a current implied inflation of 4.5% discounted in the R186, one must believe that inflation will be below 4.5% over the long term in order to see value in the R186 fixed-rate bond. We maintain that a lot of good news is priced into these bonds, and that the inflation-linkers still offer better value. The 8-12 year area of the curve, with implied inflation above 5%, is the area where nominal bonds offer value. Fixed-rate bonds at the long end of the curve are still pricing in a relatively optimistic inflation scenario.
We are maintaining our positions in inflation-linked bonds in the short and very long ends of the curve areas, where we see value in real yields. The fund had significant exposure to inflation-linked bonds at the long end of the curve, and we maintained the positions. The fund is exposed to the R194, R153 and R157 areas of the yield curve, while exposure in the longer dated R186 area has been switched to inflation-linked bonds. As a result, the nominal duration of the fund is around 0.5 year higher than the All Bond Index.
While we see value in nominal bonds where they are discounting inflation above 5%, we feel that fixed rate bonds have room to rise. Risks to be monitored over the year include:
- Further currency weakness.
- A continued deterioration of the current account as local consumers and retailers continue to import "cheap" goods.
- A reversal of the interest rate 'conundrum' in the US.
- Consumer spending and credit growth.
- Further declines in labour productivity.
Nedbank Bond comment - May 05 - Fund Manager Comment13 Jul 2005
The bond market performed poorly in May as rates ticked up across the curve. Inflation data for April came in slightly above expectations, and inflation is now off its low levels of earlier in the year.
The yield curve is discounting inflation in the order of 4.5% to 5%. While we are comfortable with the inflation scenario, we still believe that the difference between nominal and real yields (i.e. implied inflation) can widen.
Having switched just under 15% of our long bond exposure into inflation-linked bonds since Q4 2004, we maintained the positions as w e felt that inflation-linked bonds offer significant value relative to nominal bonds. For the month, rising nominal yields and falling real yields caused the level of implied inflation to rise. With a current implied inflation of 4.5% discounted in the R186, one must believe that inflation will be below 4.5% over the long term in order to see value in the R186 fixed-rate bond. Even with rates having moved up, we still feel that a lot of good news is priced into these bonds, and that the inflation-linkers offer better value.
The fund is exposed to the R194, R153 and R157 areas of the yield curve, while exposure in the longer dated R186 area has been switched to inflation-linked bonds. As a result, the nominal duration of the fund has remained around 1.15 years, lower than the All Bond index.
Risks to be monitored over the course of the year include:
- Continued currency weakness that could put upward pressure on domestic prices
- A continued deterioration of the current account
- Rate hikes in the US beyond what the market is anticipating
- Consumer spending and credit growth
- Further declines in labour productivity.
We still see value in inflation-linked bonds, given that fixed-rate bonds are still pricing in a relatively optimistic inflation scenario. We maintain our position in inflation-linked bonds at the very long end of the curve, where we see value in real yields.
We would look to switch out of inflation-linked bonds should implied inflation at the long end increase to levels where nominal bonds offer value.
Nedbank Bond comment - Apr 05 - Fund Manager Comment14 Jun 2005
The All Bond Index (ALBI) recovered some of the March losses as the Reserve Bank surprised the market with a 50 basis point rate cut. The yield curve shifted downwards and steepened as the R194 fell 43 basis points and the R157 25 basis points. Even with the yield curve steepening, the long end still outperformed as the 12+ Index returned 2,42% and the ALBI 2,06%.
The rand weakened slightly after the unexpected rate cut, but recovered its losses and ended stronger. The market is currently pricing in a 50% chance of another 50 basis point rate cut in June. With a positive outlook for inflation, sustained rand strength in 2005 will allow the Reserve Bank the opportunity for further rate cuts.
US treasuries had a strong quarter as yields fell to 4,20%. With signs that economic growth is slowing, the market consensus is that the Fed will not be able to increase the pace of rate hikes beyond the current 25 basis points per meeting - even as rising inflation becomes a concern.
Having switched around 15% of our long bond exposure into inflation linked bonds since Q4 2004, we maintained the positions as we feel that inflation linked bonds offer significant value relative to nominal bonds. With a current implied inflation of 4% discounted in the R186, one must believe that inflation will be below 4% over the long term in order to see value in the R186 fixed-rate bond.
We feel that a lot of good news is priced into these bonds, and that the inflation-linked bonds still offer better value. The fund is exposed to the R194, R153 and R157 areas of the yield curve, while exposure in the longer dated R186 area has been switched to inflation-linked bonds. We would look to switch out of inflation linked bonds should implied inflation increase to levels where nominal bonds offer value.
The bond market performed well after the sell-off in March. Inflation data came in slightly above expectations and inflation is expected to tick up from these low levels. Currently, the yield curve is discounting inflation in the order of 4% to 4,5%. While we are comfortable with the inflation scenario, we still believe fixed-rate bond yields have room to rise.
Risks to be monitored over the course of the year include:
- Unexpected currency weakness.
- A continued deterioration of the current account.
- An acceleration in the pace of rate hikes in the US.
- Consumer spending and credit growth.
- Further declines in labour productivity.
Nedbank Bond comment - Mar 05 - Fund Manager Comment28 Apr 2005
March 2005 saw the ALBI suffer its worst performance since December 2001, pushing the year to date performance into negative territory. The rand sold off in the quarter, as it went to R6,23 to the dollar. This was against the backdrop of a dollar recovery, and a sell off of emerging markets. The rand depreciated by around 10% against the dollar and about 5% against the Euro. The Reserve Bank maintained its cautious approach and left rates unchanged at the February Monetary Policy Committee meeting. The market is currently pricing in virtually no chance of a rate cut in April as the rand has retraced, while inflation is expected to experience a cyclical upturn. Rampant credit growth and a sharply deteriorating current account have led the market to believe that the opportunity for rate cuts have passed, and the forward curve is starting to price in rate hikes early next year.
US treasuries had another poor quarter as the world experienced rising bond yields in March. The Fed continued with its policy of a 25 basis point rate hike at each FOMC meeting taking rates to 2,75%, but inflation fears are causing concern that they may increase the pace of rate hikes going forward.
Having switched a significant amount of our long bond exposure into inflation linkers over the previous months, we maintained our positions as we felt that inflation-linked bonds offer significant value relative to nominal bonds.
The fund is exposed to the R194, R153 and R157 areas of the yield curve, while exposure in the longer dated R186 area has been switched to inflation-linked bonds. As a result, the nominal duration of the fund is around one year lower than the All Bond Index.
The bond market performed well for the first two months of the year, before experiencing a sharp reversal in March. Inflation releases for 2005 have continued to come in below expectations as the strong rand continues to have an effect on prices. However, the disinflationary effect of the rand is coming to an end and the market is looking for inflation to move upward over the course of the year. Currently, the yield curve is discounting inflation in the order of 4.5% to 5%, as opposed to 3.5-4.5% at last quarter end. While we see more value in the nominal bonds now that rates have risen, and we are comfortable with the inflation scenario, we still believe fixed-rate bond yields have room to rise.
Risks to be monitored over the course of the year include:
- Unexpected currency weakness.
- A continued deterioration of the current account.
- An acceleration in the pace of rate hikes in the US.
- Consumer spending and credit growth.
- Further declines in labour productivity.
Nedbank Bond comment - Dec 04 - Fund Manager Comment21 Feb 2005
The bull market continued in the fourth quarter as yields fell around 100 basis points from the three-year area out. The All Bond Index achieved a return of 7.67% for the quarter.
The rand was very strong during the quarter as it went from R6.49 to R5.63 to the US dollar. The Reserve Bank left rates unchanged during the quarter, which surprised most of the market who felt that the strong rand had given the bank an opportunity to cut rates.
US treasuries had a poor quarter as the Fed continued with its policy of a 25 basis point rate hike at each FOMC meeting. The US ten-year bond rose 20 bp towards the end of December to 4.32%.
Over the quarter, we began to see significant value in real yields relative to fixed-rate bonds. As implied inflation fell below 4% at the long end of the yield curve, we looked to switch the R186 fixed-rate bonds into inflation-linked bonds. With an implied inflation of 3.8% discounted in the R186, one must believe that inflation will be below 3.8% in order to see value in the R186 fixed-rate bond. We feel that a lot of good news is priced into these bonds, and that the inflation-linkers offer better value. We are looking to accumulate inflation-linked bonds in the short and very long ends of the curve areas where we see significant value in real yields.
The fund is exposed to the R194, R153 and R157 areas of the yield curve, while exposure in the longer dated R186 area has been switched to inflation-linked bonds. As a result, the nominal duration of the fund is around 1 year lower than the All Bond Index.
Money market rates edged up when the Repo rate was left on hold in December. Rampant credit growth and a sharply deteriorating current account are the major risks to a scenario of falling money market rates at present, and the Reserve Bank will have a difficult task in 2005 balancing the effects of the strengthening rand and its effect on inflation.
Continued rand strength led the market to believe that inflation will continue to be subdued in 2005. Currently, the yield curve is discounting inflation in the order of 3.5% to 4.5%. While we are comfortable with the inflation scenario, we believe fixed-rate bonds are fully valued.
Risks to be monitored in 2005:
- Unexpected currency weakness that could put upward pressure on domestic prices
- A sharp deterioration as local consumers and retailers continue to import "cheap" goods from overseas
- Continued inflationary pressures in the US
- Consumer spending and credit growth
- Further declines in labour productivity
Nedbank Bond comment - Nov 04 - Fund Manager Comment03 Jan 2005
The bond bull market continued in October as bond rates fell 30 to 40 basis points from two years out. The rand had another positive month and strengthened to just under 6.80 to the dollar. With bond rates falling dramatically in recent months, the 3-month ALBI return of 5.81% is well above the cash return of 1.65%.
The continued rand strength kept inflation contained, and caused the market to adjust their inflationary expectations downward. The R153 ended at 8.265%, after dipping below 8.20.
Our bearish bond outlook meant that the fund continued to be structured with duration slightly shorter than the All Bond Index. With the ALBI delivering a high return, the portfolio slightly under performed the benchmark.
Short-term rates ticked down slightly in anticipation of a rate cut at the December Monetary Policy Committee meeting. The SARB's projections see inflation rising in 2005, but staying within the target over the next two years.
Given the SARB inflation projections of inflation moving close to the 6% target, it seems unlikely that they will choose to cut rates soon. However, there does seem to be a desire on the part of the Reserve Bank to stem the rand's continued appreciation against the dollar.
The bond market strength continued due to the strong rand and its likely effect on future inflation. With long-term bonds discounting inflation in the order of 5.8%, we are comfortable with the value in the market.
However, significant risk remain, which would preclude us from being bullish at these levels:
- Currency weakness, which would raise inflationary expectations once again. The rand strengthened this month, but remained extremely volatile;
- Rising US bond yields as the Fed continues to hike rates. A strong US economy will mean that the Fed can raise short rates to neutral levels;
- An increased tolerance for inflation from the Reserve Bank is assumed with the surprise rate cut. We feel that most of the good news is in the bond market, and the risk to bonds, are mounting.
The strategy going forward will be to maintain exposure to the bond market but with duration slightly shorter than the index. We would look to increase duration once the risks decrease and we see value in the market.