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We take a look at South Africa's short and long term government bond yields. And investigate the Phenomenon called "Inverted Yield Curve". This is when short term yields are higher than long term yields. Basic economic theory dictates that long term yields should be higher than short term yields, as long term investors needs to be compensated for taking the additional risk for investing in a bond for a longer time period.
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The line graph to the left shows three variables plotted against one another.
The blue line: Long term bond yield The green line: Short term bond yield The red line: REPO rate set by South African Reserve Bank It is clear that there is a strong correlation between short term yield rates and the REPO rate (rate at which the Reserve Bank lends money to retail banks). It is to be expected that they will be closely correlated. In order for government to lure investors they should offer yields similar to the yields that the banks would be offering to clients. Hence the close relationship between these two. Now for the relationship between the long term and short term yields. For the most part the long term yields are above short term yields. But inverted yields are observed too. |
Inverted yield curves are the exception and not the rule and usually arise when there is increased demand for short term credit. And in most cases the inverted yield curve signals a pending economic contraction. In the graphic above bond yields reached their peak in June 2008, and 9 months later South Africa's economy was in the middle of a recession with annualised growth sitting at -6.1% in March 2009, as the graphic below shows.
While the current interest rate yield curve is not inverted, the difference between the long and short term yields have been narrowing in recent months, and as the first graphic shows yields spiked in December 2015 after our now infamous "Nenegate" and "weekend special" David Des Van Rooyen. Investors clearly demanding greater yields from South African bonds after the president decided to play musical chairs with South Africa's finance ministers.
But while yields have been on the increase it is not near the levels we saw before the financial crisis that started in the USA and spread to the rest of the world in 2008/2009. So while there has been a lot of coverage in news papers about our bond yields increasing to compensate for increased risk, investors and the public at large should know that the current yields on government bonds is far below levels we experienced in 2008. Infact short term yield on government bonds are down from 12.3% in June 2008 to 8% in April 2016, while long term bond yields have remained relatively stable and declined from 10.4% in June 2008 to 9.1% in April 2016.
Even though yields are not as high as they were in 2008, they are increasing, showing that investors are looking for increased compensation for holding bonds. Rising yields on bonds, means lower bond prices, which usually signifies greater selling than buying of bonds or new bonds offering greater yields pushing down prices of already listed bonds to ensure it's yield lines up with newer higher yielding bonds.
And this might be because investors demand a higher return to hold bonds, as they expect interest rates to rise, and this expectation is influenced by the expected future levels of inflation. As inflation is expected the increase, so will interest rates to curb inflation, and higher interest rates would imply higher bond yields, as bond issuers need to offer yields close to or above those that banks can offer clients.
Looking at the long term bond yields, it's recent uptick does signal that investors expect higher average levels of inflation compared to say what they expected in 2012 and 2013 when long term bond yields were much lower and higher expected inflation leads to higher interest rates which leads to a slowdown in economic growth. So based on the recent increase in bond yields and interest rates, we should see this have an impact on South Africa's economic growth in the next 12 to 18months as the higher interst rates starts to take effect in the economy.
Even though yields are not as high as they were in 2008, they are increasing, showing that investors are looking for increased compensation for holding bonds. Rising yields on bonds, means lower bond prices, which usually signifies greater selling than buying of bonds or new bonds offering greater yields pushing down prices of already listed bonds to ensure it's yield lines up with newer higher yielding bonds.
And this might be because investors demand a higher return to hold bonds, as they expect interest rates to rise, and this expectation is influenced by the expected future levels of inflation. As inflation is expected the increase, so will interest rates to curb inflation, and higher interest rates would imply higher bond yields, as bond issuers need to offer yields close to or above those that banks can offer clients.
Looking at the long term bond yields, it's recent uptick does signal that investors expect higher average levels of inflation compared to say what they expected in 2012 and 2013 when long term bond yields were much lower and higher expected inflation leads to higher interest rates which leads to a slowdown in economic growth. So based on the recent increase in bond yields and interest rates, we should see this have an impact on South Africa's economic growth in the next 12 to 18months as the higher interst rates starts to take effect in the economy.