The old normal gives way to the new normal

At the height of the Covid pandemic, zero or negative interest rates in developed economies were considered ‘normal’. Inflation was under control, there were no visible social or geopolitical risks on the horizon, and the world economy was on a sure, if plodding, course.

Two years later we have inflation at levels many people have not seen in a generation, positive interest rates, a war in Eastern Europe and an aversion to risk.

“US interest rates and bond yields are now at levels we haven’t seen in decades. This is the new normal,” says Melanie Stockigt, portfolio manager at Laurium Capital.

“Bonds that were negative yielding have now moved into positive territory. The old global monetary policy era has ended. This was where central banks pumped liquidity into the system to drive yields lower and keep interest rates down. The problem with this approach is that it fanned inflation when it emerged, and now central banks are having to wind down these policies to get inflation under control.”

The South African Reserve Bank (Sarb) demonstrated its commitment to maintaining inflation within its 3% to 6% target range. It started hiking interest rates long before the US Federal Reserve did and, in doing so, may have averted a more calamitous outcome than the one we are currently experiencing, adds Stockigt.

At the height of the Covid crisis, 30% of the components of the Bloomberg Global Aggregate Bond Index were negative yielding. Those yields have now turned positive and, in 2022, a so-called yield curve inversion occurred, which is frequently a precursor to recession. In a normal yield curve, longer-dated debt would pay out higher rates of interest. A yield curve inversion occurs when shorter-dated debt pays out higher interest than longer-dated debt.

Expressed another way, people are not willing to invest money for the long term, preferring shorter-term debt to longer-term. The yields payable on these bonds reflect supply and demand.

Have we reached the top end of the current interest rate cycle?

Probably not, says Stockigt. The current repo rate of 7.25% is the highest it’s been since 2010, but it could still go up another 25 to 50 basis points before peaking – and then falling.

While economic data from the US shows an unemployment rate of 3.4% and a fairly robust recovery from the post-Covid slowdown, the data from SA is less encouraging.

“Load shedding has become the dominant economic theme in SA, and that puts a chokehold on economic growth,” says Stockigt.

“There’s still a lot of uncertainty over inflation, which is coming down, though food inflation is much higher than anyone anticipated, and is not receding as quickly as expected. The danger is that this could feed through to wage increases, helping to keep inflation higher for longer than we would like.”

The risks in the US are of a different hue, where unemployment is low (3.4%). That means workers are in a stronger position to demand higher pay, which will create inflationary pressures later in the year.

SA’s sovereign ratings slide has stabilised

By 2020, SA had lost its investment grade credit ratings from all of the major rating agencies, due to weak domestic growth, limited capacity to stimulate growth, fiscal deficits and the rise in government debt.

This undid all the work of successive administrations since 1994 in assiduously building an international credit profile to access international credit markets.

“However, our sovereign ratings decline has stabilised, and that’s a good thing,” says Stockigt.

“S&P has got us in a positive outlook, while the other two major ratings agencies, Fitch and Moody’s, have us at stable. To improve from here we need to start sorting out the electricity crisis.

“We won’t be upgraded for a while yet, but what’s important at this stage is to put the country on a path to fixing the major structural problems it faces, and chief among those is electricity. There are others, but we must address this with urgency.”

One positive is that the debt-to-GDP ratio, which was expected (post the Covid shock) to rise from 69% in 2019 to above 90% in 2023, did not rise nearly so drastically as expected.

A strong economic rebound, particularly among commodity producers and exporters, increased tax collections by the South African Revenue Service (Sars), which offset increased social spending to address the Covid crisis.

Debt to GDP is likely to rise to closer to 75% in the near term, says Stockigt.

How actively managed is the Laurium BCI Strategic Income Fund?

The fund is invested primarily in the SA fixed-income space, with 27% of assets currently allocated to government bonds, 8% to inflation-linked bonds, 4% to offshore bonds, and 3% to domestic listed property, with the balance in a range of income-producing assets, from bank deposits to highly rated corporate bonds.

Managed by Stockigt, the fund has outperformed its benchmark each year, net of fees, since inception. Stockigt has 25 years of experience in fixed-income markets, having previously worked at Tantalum Capital and Coronation.

“Even though we are finding a lot of value in the market at the moment, we’re still conservative,” says Stockigt.

“We’re active managers. Typically, a bond fund would have a six-year portfolio duration. Ours ranges about six months to two years through the cycle. We have a flexible duration policy where we seek to protect capital in times of bond market weakness by following a defensive asset allocation strategy.

“When bond yields are attractive, we want to increase exposure, so that we can offer clients a better yield than they can get in the money market with the potential for capital gain.”

Brought to you by Laurium Capital.

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