Market Commentary




4Q19 Market Commentary

By Bongani Ngwanya, Portfolio Manager

Following a disappointing Medium-Term Budget Policy Statement (MTBPS), Moody’s sovereign rating committee finally had seen enough and revised South Africa’s (SA) outlook from stable to negative and affirmed the rating level Baa3. There are no hard and fast rules regarding when an issuer will be downgraded after an outlook change, but Moody’s history shows they take about 18 to 24 months. In SA’s case, they have stressed they would like to see decisive actions to rein in fiscal spending, show growth initiatives, improve tax compliance and other efforts to stabilise the debt ratios in the February 2020 Budget.

A downgrade from Moody’s would mean that all three of the world’s most prestigious credit rating agencies deem SA’s sovereign debt as sub-investment grade or junk. Such a scenario would result in SA’s bonds being excluded from Financial Times Stock Exchange’s (FTSE) World Government Bond Index (WGBI). In other words, the $2.18 trillion (tn) in passive funds that track the WGBI would not be allowed to hold SA bonds. SA bond weight is currently 0.41% of the index or $19.2 billion (bn) which equates R279bn. The funds that hold SA bonds would be forced to sell them resulting in bond yields rising (bond prices falling). The Rand would also be severely impacted as foreign bond holders, who hedge the currency, would unwind Rand contracts which would entail selling the currency too.

Although a downgrade from Moody’s may seem like the worst-case scenario, we’d like you to be cognisant that a downgrade in March is not a forgone conclusion. Moody’s placed the rating on negative outlook not negative watch. As we have mentioned earlier, negative outlooks take 18 to 24 months to be resolved whereas a negative watch gets resolved quickly. Given Moody’s affection towards SA, we are of the opinion they will give SA a bit more time.

If one takes a look at SA’s Credit Default Swap spread and credit risk score, you could make a strong argument that the financial markets have already fully priced the impact of a Moody’s downgrade and not much will happen when we eventually get downgraded. There are plenty of funds who don’t track the WGBI and many more who don’t want to join the $11tn invested in negative yielding debt. SA’s high real rates will continue to be a favoured destination for many funds and all this doom and gloom about a Moody’s downgrade could just be another Y2K story.