SA passes first post-Moody's test with record bond auction demand
The country's ability to attract bond investors comes at a high price as yields shoot up
SA has passed its first post- downgrade test in the markets with flying colours.
The country’s offering of bonds worth R4.53bn on Tuesday attracted record demand, with bids exceeding what was on offer by more than four times, according to Bloomberg data, as yields that are among the highest in emerging markets proved too hard to resist for some investors.
The bid-to-cover ratio, a proxy for investor demand, for about R1.5bn of 10-year bonds jumped to 4.45 times from 1.82 in the previous week. Appetite was whetted by the timing of the auction, which happened on a day of relative calm in the markets, while last week’s actions by the Reserve Bank to ease liquidity strains also helped.
It was the first auction since SA lost its last remaining investment-grade rating from Moody’s Investors Service on Friday, and was therefore an early test of whether the country can still rely on markets to fund a budget deficit that the ratings agency said could climb to about 8.5% of GDP in 2020.
SA bonds may have also got a reprieve from the delay in the rebalancing of the World Government Bond Index until the end of April, which means passive investors tracking the index do not yet have to sell their bonds, while the rand’s record lows above R18/$ made the country’s assets relatively cheap for foreign buyers.
The Treasury said it needs more time to assess market movements since the downgrade before it can make a meaningful and accurate determination of the drivers.
“Much of the repricing has happened and perhaps a smaller amount will happen later on,” said Sasfin fixed-income trader Alvin Chawasema.
“The rand has depreciated quite a bit recently. For someone who is holding US dollars, our assets become cheaper. ”
Government bonds are considered an important indicator of investor sentiment towards a country, representing loans made by investors to the government. Yields, which move inversely to prices, adjust to reflect investor perceptions of potential capital losses or even default.
Rand Merchant Bank fixed income analyst Deon Kohlmeyer said measures taken by the Reserve Bank to ease liquidity pressures in the market have helped to “reduce the stress in the system” and that he is hopeful that the country will continue to attract investors as the global risk environment improves.
But it’s not all good news. To keep getting investors to buy the bonds, SA has to pay higher interest, which was reflected in the yields in Tuesday’s auction. As the government’s borrowing needs increase, the amount of national income taking up interest-service costs will do the same, reducing resources available for key services such as education and health.
“Government funding costs are high across the curve now” and “that is not good”, said James Turp, head of fixed income at Absa Investment Management. “Also presumably we will need to fund more given the current state of our economy. Down the line, it is going to lead to higher servicing costs in the fiscus.”
The yield on the R2030 government bond dipped below 11% on Tuesday, having reached a record above 12% last week, before the Bank stepped in to ease market tensions.
Comparable US treasuries yield less than 1%. Based on pricing at Tuesday’s auction, SA has to pay just more than 7% to borrow for just three years, a situation that can only be fixed by a stronger economy that enables the country to reduce its borrowing. “The only way to reduce your funding costs is by issuing less and by improving your economy,” Turp said.
The rand was 0.8% stronger at R17.7882/$.