Ané Craig, Assistant Fund Manager at PSG Asset Management

This year has become known as the ‘year of elections’. Although there were 66 national elections in 2024, two stand out as having material implications for South African investors. The first is of course the local elections held in May this year and, unsurprisingly, the second is the recent US elections.

Following Donald Trump’s election to the White House, markets positioned for higher US growth - visible through the stronger US dollar, a rally in US equities and a moderate sell-off of US bonds. Conviction in this view strengthened once the Republican Party secured both houses of Congress, which means that President-elect Trump should have high odds of having his policies approved.

From a cyclical viewpoint, it is more likely than not that we will move from an environment of moderate inflation and growth to one of above-trend global growth and inflation. The new US government’s policies seem to play into this cyclical view. This includes the deregulation of the US corporate sector, corporate tax cuts and higher wages (as the labour market would tighten if parts of the current workforce were made to leave the US). Typically, energy stocks, commodities and real estate do well in the type of ‘inflationary boom’ environment that we are likely heading towards. Developed market bonds like US Treasuries do less well, as inflation erodes the real return on bonds, and they become less attractive relative to equities. Over and above the cyclical factors that may negatively impact on developed market bonds, the US fiscal position poses a structural threat to bond returns. The US debt-to-GDP ratio is 124% and still climbing. The annual interest bill of US$1.1trillion (on total government debt) is nearly double what it was in 2020.

Sources: PSG Asset Management and the Federal Reserve Bank of St Louis (FRED)

Despite big headlines about cutting fiscal spending, it may prove difficult (even for Elon Musk) to reduce government expenditure in a meaningful way if Trump were to remain true to his campaign promises (such as not to cut Medicare or defense spending) and reduce tax revenue, particularly alongside the enormous annual interest bill. The more likely result is that the US Treasury will continue increasing their debt stock to fund government expenditure, and if inflation does return in a meaningful way, the cost of that debt could rise materially.

By contrast, the South African Government’s cost of debt is already very high. Investors are funding our government at a real yield of 6.0%, compared to the roughly 2.0% above inflation which governments considered to be less risky have to pay. For the South African risk premium to shrink, our government, like the US government, must reduce its level of debt (currently expected to peak at 75.5% of GDP in 2026). This will attract more capital to both our bond and equity markets. South Africa has a long track record of overpromising and under-delivering on both the growth and fiscal consolidation necessary to reduce the debt-to-GDP ratio. However, for the first time in 15 years, the potential exists to achieve GDP growth of more than 2.0%. The country’s growth potential has been eroded over a number of years. Having now reached crisis points on several fronts, including water, transport and (lest we forget) electricity infrastructure, even marginal improvements in these areas are positive for growth. Should structural improvements in our economy coincide with higher commodity prices (as we usually see during ‘inflationary boom’ periods), the local economy could achieve levels of growth last seen before the global financial crisis (in 2008/9).

Economic growth is not as detrimental to emerging market bond returns as it is to developed market bond returns. This is particularly true if domestic inflation remains anchored at low levels. While South Africa is not immune to global factors that put pressure on inflation, a key difference domestically is lower levels of government spending (which is typically inflationary) and slack in the labour market (as high unemployment keeps wage price pressure contained). Furthermore, the South African Reserve Bank (SARB) is committed to bringing inflation within the lower end of the 3.0% to 6.0% target band and has a credible track record of controlling inflation).

The prospects for South African bonds (finally) appear very positive, even if domestic inflation does pick up moderately. However, as the saying goes – when the US sneezes the world catches a cold. There are several reasons to be cautious on US and other developed market bonds. These risks typically spill over to our bond market, even if only temporarily. While patient investors should be well-rewarded for investing locally, using a trusted fund manager to navigate the many known risks on the horizon will be crucial.