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Bonds, the monetary surprise and fiscal dominance

Bonds, the monetary surprise and fiscal dominance

author

Walter De Wet, Reezwana Sumad

Posted 25/07/2023 2 mins

2 mins

There is an unwritten rule that says one should favour bonds (or duration more broadly) whenever there is a dovish monetary policy surprise. Some call it “the Golden Rule”. In the case of South Africa (SA), this rule has been highly predictive over the past 20 years. However, fiscal dominance of ultra-long bonds has been diluting this rule, suggesting a structural bias for shorter-duration bonds in a scenario where monetary policy is a key input for one’s bond view.

The Golden Rule holds but has lost some shine

While SARB’s policy stance remains a key driver of bond performance relative to cash, its predictive power has waned over the past 10 years. Where the monetary policy surprise was 85% correct in predicting excess bond returns from 2013 to 2015, this is now down to only 73%. The decline in the rule’s predictability coincides with SA’s credit rating cycle.

Fiscal dominance of long-dated bonds is large and growing

We estimate the impact of fiscal policy on different maturities along the yield curve. The effect of fiscal policy, via higher debt levels, is now dominating long-dated bond yields by some margin. Our estimates suggest fiscal policy is responsible for 69% of the 30-year bond yield, up from 60% a decade ago and even lower before that. This rise in fiscal dominance would explain the decline in the influence of monetary policy on bond returns overall.

An EM peer comparison suggests SA’s fiscal influence is on the higher side but not an outlier

We estimate the impact of fiscal and monetary policy on other EM peers and focus on the 10-year bond yield. For the 10-year yield, SA’s fiscal policy seems to have a larger impact on the 10-year bond yield than other EM peers’. By extension, our estimates suggest monetary policy’s impact is smaller than EM peers’.

Ultra-long bonds seem mute to domestic monetary policy

The “pivot”, where fiscal policy starts to dominate all other factors, seems to be within the 12- to 15-year maturity bucket. The Golden Rule remains applicable, in our view, and monetary policy a key driver of bond returns, but we suggest it does not hold for the whole curve anymore. 

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