May madness strikes SA bonds but there’s no panic ... yet
May saw the largest outflows of foreign capital in a single month on record, but economists are OK with it
Some in the market are calling it “May madness”.
The month of May saw the largest outflows of foreign capital in a single month on record, as Nedbank CIB pointed out this week, with R50-billion of net outflows, R30-billion of this from the bond market and the rest from the equity market.
Latest JSE statistics show foreigners were net sellers of SA bonds to the tune of almost R6-billion for the year to date; over the same period last year they were net buyers (of R45-billion). Foreign equity purchases are still positive for the year to date, but were less than a fifth of what they were at the same time last year.
The drivers of May madness were global not local, with investors losing their appetite for emerging market risk in response mainly to dollar strength and US bond yields going over 3%, but also to ructions in Europe and financial woes in Argentina and Turkey.The Institute for International Finance estimated this week that portfolio outflows from emerging markets accelerated to $12.3-billion in May, from $0.3-billion in April. And though the IIF urges “looking through the turbulence”, the key downside risk is that a 10% appreciation in the dollar could cut annual net capital inflows to emerging markets by some $95-billion, it estimates.
All of this matters for at least two reasons: South Africa runs a deficit on the current account of its balance of payments which has to be financed by capital inflows and since it doesn’t get much foreign direct investment, it has to rely on portfolio flows into its bond and equity markets.
Back in the taper tantrum of 2013, SA was on the list of the “fragile five” emerging market countries whose currencies and capital flows were hammered the most because of their high current account and fiscal deficits. SA’s current account deficit has come down significantly since then and far from being top of anyone’s fragile list, its new political leadership has made it something of a darling among emerging markets. But it remains vulnerable to sudden stops in capital flows.That’s particularly so because of how dependent SA has become on foreign bond market investors to fund the borrowings government has run up to finance the sizeable fiscal deficits of the last few years. Latest Treasury figures show foreign ownership of SA’s domestic government bonds hit a high of 42.7% in April, up from 39.4% a year before. The risk of a foreign bond market sell-off is one of the “external” risks that rating agencies flag for SA.
Fortunately, unlike many other emerging markets, SA has well developed, liquid capital markets at home, and locals have been buying the bonds the foreigners have been selling – which is why bond yields haven’t widened as much as might have been expected given May’s sell-off.
The yield on a bond is the inverse of its price so a rising yield is a falling price. The yield on the benchmark R186 bond – of which foreigners owned 55% in April – rose from 8.18% at the end of April to 8.57% at the end of May, which is large but not so large given the outflows.
Ashburton Investments fund manager Nico Els says a lot of local real money investors were underweight bonds and had been waiting for weakness so they could up their holdings. Foreigners had piled into the domestic bond market after the ANC’s December conference, lifting the R186 yield from 9.50% to a best level of 7.83% at the end of March, but locals were fussy, says Els, in part because they were more cautious initially about SA’s political turnaround story.But global rather than local factors are now the key drivers for SA’s bond market and the big question is what happens globally and how serious is the risk of another taper tantrum-type emerging market selloff.
The IIF said this week that “the drop in US 10 year bond yields since mid-May should provide more solid footing for EM portfolio debt and equity inflows in the near term” and its forecasts on SA, where it sees net capital inflows for 2018 increasing to $12.9-billion from $10.5-billion in 2017, are more positive than on most of the other emerging markets it monitors.
Standard Chartered economist Razia Khan is also still positive, despite the global “recalibration” of emerging market risk premia in response to higher US yields.
“The institutional support for emerging market debt as an asset class has remained intact so far,” she said. “Better returns even in real terms are still available in emerging markets and we should see a resumption of flows.”
SA will have to hope she is right.