Bonds shine as trade and GNU tensions fade

Trump-era policies take root

The rejection of incumbency in voter patterns during the 2024 national elections was always going to spill over into disruptive policy initiatives. The Trump-led US has led the change, guided by a four-pronged policy agenda focused on trade, fiscal policy, immigration, and deregulation. The 90-day reprieve on the highest reciprocal tariffs has quelled financial market jitters and stemmed US recession fears. However, progress toward trade deals with major trading partners has been predictably slow. Until then, policy uncertainty will remain elevated, continuing to weigh on trade and investment activity.

US immigration and fiscal policy have also gained prominence in the global narrative, adding further layers of risk and uncertainty to US economic prospects. The One Big Beautiful Bill, a sweeping fiscal bill tabled in May, is the centrepiece of the Trump administration’s plans, but its stimulatory tilt – introduced despite already stretched government finances – raises concerns about fiscal sustainability and whether the current term premium of US Treasury bonds is adequate. The incompatibility of the administration’s policy objectives is becoming increasingly apparent, with the risk of structurally higher inflation and fiscal dominance emerging as a likely legacy.

In the short term, this macroeconomic backdrop has dispelled the “US exceptionalism” narrative. Rather than serving as a tailwind to global growth in 2025, as many had expected at the year’s outset, the US now poses downside risk.

Ironically, the isolationist MAGA policies, which include restraining US North Atlantic Treaty Organization (NATO) contributions and military support for European allies, will spur elevated fiscal expenditure on state security and infrastructure in Germany and across the broader Euro area. This has improved medium-term growth prospects and mitigated European financial market losses relative to those in the US.

Meanwhile, in the East, China remains marred by persistent deflation and economic stagnation. The devolving trade conflict with the US, China’s largest trade partner, now presents a further challenge to its economic recovery.

Cracks, Patchwork, and a Narrow Majority

Domestically, the fiscal estimates tabled in the third iteration of the national budget were pragmatic and credible. They struck a careful balance between a continued commitment to debt containment, social security commitments, and growth-enhancing capital formation. However, the scrapping of the value-added tax (VAT) proposals from the two failed budgets will curtail medium-term fiscal revenue collection and dampen the scope for stimulatory fiscal expenditure. Additionally, fiscal flexibility remains constrained. In an increasingly fraught geopolitical climate, a small, open economy like South Africa’s remains highly exposed to exogenous shocks, with little capacity to implement meaningful counter-cyclical fiscal measures during downturns.

While the cracks exposed in the governing coalition by the two previous failed budget iterations have been papered over, they have nonetheless highlighted the frailties of coalition politics. Domestic bond market participants continue to adjust to these realities, now demanding less risk premium as uncertainty around the durability and composition of the coalition agreement begins to subside.

Headline consumer price inflation edged up slightly to 2.8% y/y in April, from 2.7% y/y in March. We expect consumer prices to gradually rise in the coming months, although inflation expectations remain well anchored below the midpoint of the target band. The current disinflationary environment has created an opportunity for the South African Reserve Bank (SARB) to not only continue its gradual rate cutting cycle, while also offering explicit forward guidance to re-anchor expectations closer to the bottom of the prevailing 3-6% inflation target band.

In the near term, the benign inflation outlook will be supported by threats to global growth and easing energy prices. However, beyond the near term, global trade policy and disrupting supply lines will continue to threaten long-term producer and consumer price stability.

Long-dated bonds outperform as GNU tensions fade

The domestic nominal yield curve shifted lower and flattened in May. The 7–12-year segment of the All Bond Index (ALBI) was the top performer of the nominal bond curve, delivering a return of 3.64%, compared to the ALBI total return of 2.73% over the same period. Cash, as proxied by the STeFI Call Deposit Index, returned 0.61% in May, while the IGOV Index, which comprises sovereign-issued, local currency inflation-linked bonds (ILBs), returned 0.49%.

Figure 1: Bond market index returns (periods ending May 2025)

Source: IRESS, Futuregrowth

THE TAKEOUT: The Trump administration has hit the ground running in pursuit of its incompatible MAGA objectives, hampering investor and consumer confidence and heightening market volatility. This has dented the “US exceptionalism” narrative, and far from offering a tailwind to the global growth outlook at the onset of the year, the US now poses near-term downside risk. Domestically, the fiscal estimates tabled in the third iteration of the national budget were pragmatic and credible. The cracks exposed in the governing coalition by the two previous failed budget iterations have been papered over but have nonetheless highlighted the frailties of coalition politics.

Our investment view and strategy

Politics will continue to have an outsized influence on the performance of financial market assets in the months and years ahead as the Trump administration advances its Make America Great Again agenda. To date, this policy path has undermined investor and consumer confidence – the bedrocks of spending and investing. Heightened market uncertainty will likely translate into weaker macroeconomic growth outcomes in the near term and reinforce expectations of Fed rate cuts. This environment also supports the case for domestic monetary policy easing, given still-modest economic growth conditions and range-bound inflation expectations.

Locally, government finances show nascent signs of stabilisation but will remain an important watchpoint in our management of local currency bonds, given the strong link between macroeconomic conditions and government finances.

The confluence of a seemingly stabilising fiscal position and an easing monetary policy cycle provides a favourable backdrop for nominal interest rate risk. The local bond market has paid back some of the extraordinary capital gains following the formation of the GNU – a development we had anticipated in recent months. The accrual offered by nominal bonds has anchored our investment strategy, and we continue to accumulate interest rate risk into the periodic bouts of market weakness.

While the inflation carry in ILBs has waned, the asset class continues to offer attractive returns relative to cash in the medium term. However, we maintain a strategic preference for nominal bonds, given their elevated carry and improved capital return prospects.

THE TAKEOUT: Our investment strategy aims to strike a balance between: 1) capitalising on the base accrual (carry) on offer, especially relative to cash; 2) participating in the roll-down potential offered by short-dated bonds; and 3) active modified duration management, seeking to maximise capital gain opportunities.  

Table 1: Key economic indicators and forecasts (annual averages)