Much of the upside for bonds has compressed as cash looks competitive

Our model fair value (FV) for key nominal bond maturities moves marginally higher

After a strong rally in bonds in the past two months and another month of fiscal data for South Africa (SA) that became available last week, we revisit our bond estimates and bond strategy for nominal bonds and ILBs. Given our baseline assumptions, our model result provides us with a 10-year FV of 10,9%, marginally up from our previous FV of 10,7%.

We remain cognisant that fiscal dominance is high

We believe fiscal dominance of ultra-long bonds is high and growing. Our estimates suggest that almost 70% of the 30-year bond yield is driven by local fiscal policy, making ultra-long bonds largely “mute” to less hawkish monetary policy.

Issuance increases on average, sees curve steepening despite this topic being well covered

There is a real and growing risk that weekly auction sizes for nominal bonds would need to increase. Despite the government’s financing requirement being a well-researched topic, it appears that the curve still steepens after an announcement that nominal bond issuance will increase. In short, any issuance increases may not be well priced.

Nominal bonds seem more of a “hold” rather than a “buy” right now

We believe the space for yields to rally has largely compressed for front-end and ultra-long bonds where expected returns are like those of cash. If cash is not preferred, our expected return estimates suggest the R2030 to R2037 area still provides most value. Our 12-month expected return for the ALBI index now stands at 11,1% (vs cash at 9,5%).

ILBs could see some pressure; our 10-year FV moves up, too

We believe upward pressure on real yields is building as fiscal risks materialise. Our 10-year FV is now at 4,9%, up from 4,7% previously. Our expected return for the CILI index is 9,1% (vs cash at 9,5%). For ILBs, our general view is that less duration is better.

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