Nedbank Bond comment - Sep 06 - Fund Manager Comment14 Nov 2006
After rising 10-20 basis points in August, bond yields fell in September by a similar amount to end the quarter at roughly the same levels as where they started. In line with expectations, the SA Reserve Bank hiked the repo rate by 50 basis points at the August Monetary Policy Committee meeting. The ALBI returned 2,07% for the quarter, slightly outperforming cash.
- With rates ticking down around 5 basis points between 10 and 20years, the long sectors of the yield curve outperformed. The short end of the yield curve was the worst performing sector (1,62%), under performing cash.
- The rand depreciated significantly, falling 59 cents against the dollar and 75 cents against the euro to end at R7,74/USD and R9,84/Eurorespectively. This equates to a sharp depreciation for the quarter of around 8 % against both currencies.
- After raising rates by 25 basis points at every meeting for the last two years, the Fed left rates on hold at the August and September FOMC meetings. US treasuries rallied dramatically, with many seeing this as the end of the cycle of rate hikes. The 10-year benchmark fell 57basis points to 4,63%, with the market viewing the cooling economy and housing market as sufficient to prevent any further hikes. The market has effectively priced in the end of the rate hike cycle, with rates beginning to fall by the end of the Q1 2007. However, there is still a great deal of uncertainty regarding inflationary pressures in the US economy and the path of the Fed Fund's rate.
The fund's current duration is 3.69 versus the ALBI duration of 4.57.During September, the fund entered into an R157 option position. With options, if rates go up, the duration of the fund falls to 3.55, while if rates come down, the fund duration increases to 3.82. This means that the portfolio duration is variable with respect to the level of rates, but overall remains short relative to the ALBI. We have looked to enhance yield in the fund through some credit exposure, and we have maintained swap exposure in the short and medium areas of the yield curve. Due to bond-swap spreads being attractively priced, we have added further swaps in the R153 area of the yield curve, while maintaining swap positions in theR194 area. The portfolio is positioned to generate out performance in a scenario of rising interest rates.
Nedbank Bond comment - Jun 06 - Fund Manager Comment11 Sep 2006
There was a significant sell-off in the bond market in June as severe currency weakness and an unexpected rate hike by the South African Reserve Bank caused yields to rise dramatically. The negative sentiment towards emerging markets continued in June, with the risks to South Africa being highlighted by its large current account deficit. SA bond yields shifted up between 80 and 120 basis points across the curve, while international bond yields continued to tick up as there remains a definite bias towards rate hikes among central banks worldwide.
The ALBI returned -3,61% for the month and -3,58% for the quarter, underperforming cash by a large margin. o SA bond yields shifted up between 80 and 100 basis points across the curve from five years out, with the short end shifting up by more than a 100bp due to the surprise rate hike. Longer assets underperformed and the 12+ area of the index achieved the lowest return of -6,42%, while the 1-3 year area, which returned -1,09%, was the best performer.
o The rand continued to depreciate in June, as a greater than expected current account deficit highlighted the need for an adjustment in the currency, while the dollar was stable against the euro. For the month, the rand weakened around 45 cents against the dollar to end at R7,15/USD, while weakening 46 cents against the euro to end at R9,09/Euro.
o US treasuries ticked up as the Fed hiked rates a further 25 basis points to 5,25% as expected. There is still a great deal of uncertainty regarding inflation and the path of the Fed Funds rate. The US tenyear ended the month 14 basis points higher at 5,19%. The current duration of the fund is 3.94 versus the ALBI duration of 4.57. This means that the portfolio is positioned to generate some outperformance in a scenario of rising interest rates, while having a closer duration of the Bond Index in a scenario of falling interest rates.
The duration of the fund has been brought closer to the index as the ALBI duration has fallen and we will look at structures to add exposure as we see value. We have looked to enhance yield in the fund through some credit exposure and we have taken further exposure in interest rate swaps in the 4-year area.
Further risks to be monitored over the course of the year include:
o A continued deterioration of the current account;
o Consumer spending and credit growth; and
o Rising oil and petrol prices, as well as the potential second-round inflationary impact from higher oil prices.
Nedbank Bond comment - Mar 06 - Fund Manager Comment21 Jun 2006
The option position in the fund was maintained for the quarter. The current duration of the fund is 4.4 versus the ALBI duration of 4.9. With the options, if rates go up, the fund duration drops to 3.9, while if rates comedown, the fund duration remains 4.4. The portfolio is positioned to generate some outperformance in a scenario of rising interest rates, while having a closer duration of the bond index in a scenario of falling interest rates.
A switch out of R194's and into swaps was also done so as to enhance the yield of the fund. The Reserve Bank left the repo rate unchanged at 7% in February. Risks to the inflation outlook were outlined as follows:
o Rising global oil prices;
o Rising food prices; and
o Buoyant domestic demand underpinned by growth in credit extension.
SA bonds are currently discounting domestic inflation in the order of4.2%. SA nominal bond yields are fairly valued and likely to remain around current levels.
Risks to the SA bond market are currently increasing as rising global yields weigh on the local market.
The currency risk premium on the rand is currently in the order of1.9%. With rising international interest rates and a threatening current account deficit, the attractiveness of the rand is at question.
Further risks to be monitored over the course of the year include:
o A continued deterioration of the current account;
o Consumer spending and credit growth; and
o Rising oil prices and the potential second-round inflationary impact from higher oil prices.
The portfolio's effective duration is short, but exposure to bond options will lengthen our duration somewhat if rates fall. We have looked to enhance yields in the fund through some credit exposure, as well as interest rate swaps.
With narrowing interest rate differentials, a deteriorating current account and rising oil and food prices, we see the risk of rates ticking up going forward and will thus maintain our short position until we see value in the bond market.
Nedbank Bond comment - Dec 05 - Fund Manager Comment24 Jan 2006
At the end of Quarter 3, the fund had significant exposure to inflation-linked bonds at the long end of the curve. Real yields have rallied very strongly over the past few months due to a pick-up in inflation and a re-rating of the inflation-linked bond yields, with the R186 discounting 5% inflation (up from 3.5% a year ago). At these levels linkers looked expensive and we sold out our position to lock in profits.
The low volatility in the bond market means options on bonds have become cheap with the result that the risk/reward ratio on options purchased has become very favourable. With the proceeds from the inflation linkers, we bought money market assets and bond options. The current duration of is 4.1 versus the ALBI duration of 4.94. With the options, if rates go up, the fund duration drops to 3.78 while if rate rates come down, the fund duration increases to 4.54. This means that the portfolio is positioned to generate some outperformance in a scenario of rising interest rates, while having a closer duration of the bond index in a scenario of falling interest rates.
The Reserve Bank decided to leave interest rates unchanged in October with the tone of the SARB very hawkish.
However, since the October MPC, the currency has strengthened, the oil price softened, inflation has surprised to the downside, unit labour costs are lower and GDP is strong. At the December MPC meeting the tone of the SARB was a lot less hawkish due to favourable economic conditions, which improved the SARB'S inflation forecast. The market has shifted away from pricing in a 100b.p. hike in a year's time, and is currently pricing in virtually no hikes over the next year.
Bonds performed strongly in Quarter 4 as falling oil prices and favourable inflation buoyed on the market. After lagging for the year as a whole, the long-dated bonds performed best for the quarter.
The narrowing of interest rates between SA and its main trading partners remains a risk to the prospects for the rand going forward. With the US rates rising, the differential to SA is narrowing with the result that the relative attractiveness of the rand is diminishing. With the Euro zone also raising rates, it means that our narrowing interest rate differentials along with the deteriorating current account is an issue that will have to be addressed somewhere down the line. This threat to the economy will ultimately put pressure on the Reserve Bank to raise rates.
Further risks to be monitored over the course of the year include:
- A continued deterioration of the current account as local consumers and retailers continue to import "cheap" goods from overseas
- Rising international yields
- Consumer spending and credit growth. Retail/ Car Sales as well as credit continue to grow at unsustainable levels.
- The potential second-round inflationary impact from higher oil prices.
Having switched out of inflation-linked bonds, we switched into money market and bond options. The effective duration of the fund is short, but exposure to bond options will lengthen our duration if rates fall.
With narrowing interest rate differentials and a deteriorating current account, we see the risk of rates ticking up going forward and will thus maintain our short position until we see value in the bond market.
Herman Steyn & Guy Toms
Prescient Investment Management