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Investors price rate rise into bond buys

Stephen Gunnion and Robert Brand

LOCAL investors are buying floating-rate corporate debt instead of fixed-rate instruments to reduce volatility in their portfolios as they bet interest rates will start to rise from their lowest level in at least 30 years.

While traders are pricing in a more than 50 percent chance the Reserve Bank will probably cut borrowing costs within four months, forward rate agreements show them starting to rise again in the next year as the bank moves to keep inflation within its 3 percent to 6 percent target. Higher oil and food prices and a weaker rand may fuel inflation, according to Stanlib Asset Management, South Africa’s largest bond investor.

South Africa, which imports most of its oil needs, increased petrol prices by 8.4 percent on Wednesday following a 9.6 percent rise in oil prices last month. The rand fell 3.4 percent against the dollar in the past month, the worst performance out of more than 25 emerging market currencies monitored by Bloomberg, increasing import costs. The inflation rate fell to a 14-month low of 4.9 percent in July.

“If the currency stays where it is and oil prices continue to stay at stronger levels, it will have implications for inflation,” said Victor Mphaphuli, a fund manager at Stanlib. “It makes sense to start moving into floating-rate instruments because you’re not going to get additional benefit from fixing your instrument at the bottom of the interest rate cycle.”

Floating-rate notes pay a coupon linked to the interest rate of another financial instrument, such as the Johannesburg interbank agreed rate (Jibar). They provide protection against rising interest rates, while paying lower yields than fixed-rate bonds.

Mining firm Northam Platinum on Monday said it sold R1.25 billion of three-year floating-rate notes at 350 basis points over Jibar, or 9.25 percent at the current Jibar rate of 5.75 percent. That compares with a yield of 5.41 percent for fixed-rate government bonds of similar maturity.

“You get a higher yield without having to carry the duration risk of longer-dated fixed-rate debt,” said Mark le Roux, a fund manager at Coronation Asset Management.

Traders are betting on a second rate cut even after Reserve Bank governor Gill Marcus said on July 29 that future reductions could not be taken for granted. A survey of 14 economists saw inflation averaging 5.6 percent this year.

“Central bank actions have become the biggest driving force” of interest rate markets, Malcolm Charles, a fund manager at Investec Asset Management, said in an interview.

“As soon as that becomes the case, you are at the whims of people, who are unpredictable, so therefore you want to de-risk your portfolio; you don’t want to be geared towards any unpredictability.” – Bloomberg

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