Fed Alarm as Commodities Drop Punishes South African Debt

By Robert Brand

South African bonds are on course for their worst returns in eight months, with more pain probably ahead, squeezed between tumbling commodity prices and an emerging-market selloff sparked by the Federal Reserve.
Local-currency debt fell in September, what would be the first monthly decline since January, according to Johannesburg Stock Exchange indexes. The securities lost 6.1 percent for dollar investors in the period, the most after Brazil among 31 developing nations tracked by Bloomberg.
Foreign investors were net sellers of South African bonds for the third straight month in September amid mounting speculation the
Fed is prepared to raise interest rates at a faster pace than some investors anticipated. That’s putting pressure on the rand, which slid 5 percent versus the dollar in the period, at a time when falling commodity prices including platinum and gold weigh on exports and growth prospects.
“South Africa is bracketed both as an emerging market and as a commodity exporter, so it’s a double whammy,” Mohammed Nalla, head of strategic research at Nedbank Group Ltd., said by phone from Johannesburg on Sept. 26. “It boils down to your rand view, and in the longer term there is still scope for more rand weakness,” which may affect yields, he said.

High Rates

Shrinking demand from China, the biggest buyer of South African raw materials, is raising concern the nation’s current-account deficit will widen as exports decline, hurting the rand and outweighing the lure of relatively high interest rates. China accounted for about 14 percent of South Africa’s exports in 2013, according to government data.
China’s economy, the world’s second-largest, will grow 7.3 percent this year, according to the median forecast by analysts in a Bloomberg survey. That would be the slowest pace in more than two decades and compares with the government’s target of 7.5 percent.
“The key is that global growth outside of the U.S. is coming off, and that’s dominating people’s minds,” Jean-Pierre du Plessis, an investment strategist at Prescient Investment Management, which oversees about $8.3 billion, said by phone from Cape Town on Sept. 26. The outlook for South African bonds “really depends on the global picture,” he said.

Yield Advantage

A slide in the Bloomberg Commodity Index (BCOM) last week to a five-year low means there’s little to support the South African currency, which retreated to the weakest level in eight months on Sept. 25. The rand fell 0.6 percent to 11.2955 per dollar by 1:29 p.m. in Johannesburg, and may depreciate to 11.60 over the coming months, according to Nalla at Nedbank.
The weaker rand is eroding returns of South African debt for foreign investors, who sold a net 4.1 billion rand ($365 million) of the securities in September after dumping 2.1 billion rand in August, according to JSE data. Yields on rand bonds due December 2026 rose eight basis points, or 0.08 percentage point, to 8.32 percent today, for a monthly increase of 34 basis points.
Higher Fed rates would reduce the rand’s yield advantage over the dollar, further damping demand for South African debt, Du Plessis said. The Reserve Bank left its benchmark unchanged at 5.75 percent on Sept. 18 to support the ailing economy. That compares with a U.S. target for overnight lending between banks in the range of zero to 0.25 percent.
The prospect of higher U.S. rates is weighing on currencies from Brazil to Hong Kong. Only the Chinese renminbi gained against the dollar this month out of 24 emerging-market currencies tracked by Bloomberg.
“This is primarily an emerging-market story,” Nalla said. “For South Africa, there is undoubtedly a commodity element to it too.”