Bonds shine through the uncertainty and volatility

Trump stamps his mark on the US economy

The Trump administration’s four-pronged policy path – focused on trade, fiscal policy, immigration, and deregulation – firmly took root this past quarter with the passage of the One Big Beautiful Bill through Congress, the centerpiece of its policy agenda. A critical watchpoint for financial markets has been the extension of the federal debt ceiling, with the bill expected to add an estimated $3 trillion to federal debt over the coming decade. Its stimulatory tilt, despite already stretched government finances, raises concerns about fiscal sustainability and the adequacy of the current term premium of US Treasury Bonds. The signing of the bill follows shortly after Moody’s one-notch downgrade of the US long-term sovereign credit rating from Aaa to Aa1, reflecting the ultra-loose fiscal path and ballooning debt service costs.

US fiscal policy developments dominated headlines, overshadowing the lapse of the 90-day truce on “Liberation Day” tariffs, which sparked market volatility and uncertainty earlier in the quarter. These sweeping tariffs were imposed on 185 nations, and with only a narrow window for negotiation, progress towards trade deals was always going to be challenging. By end June 2025, only the UK and Vietnam finalised trade deals with the US. The +100% tariffs and retaliatory tariffs waged between the US and China at the start of the quarter likely marked the peak of the tariff war, but tariffs and related trade barriers remain key risks to the real economy and financial market stability in the coming months, weighing heavily on trade, investment activity, and market sentiment.

This shifting macroeconomic backdrop has effectively shattered the “US exceptionalism” narrative – a major driver of capital flows to the US in recent years. Rather than supporting global growth in 2025, as many had expected at the year’s outset, the US now poses downside risk. Ironically, the isolationist tilt of MAGA policies, which include restraining US North Atlantic Treaty Organization (NATO) contributions and military support for European allies, is expected to spur elevated fiscal expenditure on state security and infrastructure across Germany and the broader Euro area. This has improved medium-term growth prospects in the region and propelled the performance of European financial market assets compared to those in the US.

Meanwhile, in the East, China continues to gradually tackle its investment excesses and migrate towards a demand-led growth model. This transition was always expected to be slow and bumpy, with persistent deflationary pressures. The ongoing trade conflict with the US, China’s largest trade partner, now presents a further challenge to its macroeconomic realignment.  

Re-anchoring inflation expectations

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

While the cracks in the governing coalition – exposed by the two previous failed budget iterations – have been papered over, they nonetheless highlighted the frailties of coalition politics. Domestic bond market participants have continued to adjust to these realities and are now demanding a lower risk premium as uncertainty around the durability and composition of the coalition agreement begins to subside. The axing of Democratic Alliance (DA) member Andrew Whitefield as Deputy Minister of Trade, Industry and Competition is a case in point. While the episode ruffled feathers within the Government of National Unity (GNU), financial markets responded with relative calm to both his dismissal and the DA’s performative stance on the matter.

Headline consumer price inflation was unchanged at 2.8% y/y in May. While we expect consumer prices to rise gradually in the coming months, inflation expectations remain well anchored below the midpoint of the target band. Domestic price dynamics not only support arguments for further interest rate cuts by the South African Reserve Bank (SARB) in this cycle but also provide an ideal opportunity to re-anchor expectations lower. The SARB has been proactive in this regard, with Governor Lesetja Kganyago consistently advocating for a 3% inflation target. Both inflation expectations and bond market pricing reflect the effectiveness of this forward guidance.

In the near term, the benign inflation outlook will be underpinned by threats to global growth prospects and easing energy prices. However, global trade policy will continue to lurk as a medium-term risk to both producer and consumer price stability.

Nominal bonds significantly outperform

The domestic nominal yield curve shifted lower over the quarter, with the yield on the 10-year maturity R2035 tightening by 66 basis points. The 7–12-year segment of the All Bond Index (ALBI) led the performance of the nominal bond curve, delivering a quarterly return of 6.87%, compared to the ALBI total return of 5.88%. In contrast, cash, (as proxied by the STeFI Call Deposit Index) returned 1.80% over the quarter, while the IGOV Index, which comprises sovereign-issued, local currency inflation-linked bonds (ILBs), lagged with a return of 0.88%.

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

Source: IRESS, Futuregrowth

THE TAKEOUT: The Trump administration’s four-pronged policy path, focused on trade, fiscal policy, immigration, and deregulation, firmly took root in the past quarter with the passage of the Big Beautiful Bill through Congress, the centrepiece of the administration’s policy agenda. US fiscal policy developments dominated headlines, overshadowing the lapse of the 90-day truce on “Liberation Day” tariffs, which were a key source of significant uncertainty and market volatility earlier in the quarter.

This shifting macroeconomic backdrop has effectively shattered the “US exceptionalism” narrative – a key driver of financial market flows to the US in recent years. Domestically, the fiscal estimates tabled in the third iteration of the national budget were pragmatic and credible. Still, the cracks exposed in the governing coalition by the two previous failed budget iterations, though temporarily papered over, have highlighted the inherent frailties of coalition politics.

Our investment view and strategy

Politics is set to remain a key driver of financial market performance as the Trump administration advances its Make America Great Again agenda. To date, this policy path has undermined investor and consumer confidence – both critical foundations for spending and investment. Elevated market uncertainty is likely to weigh on near-term global growth and reinforce expectations for a gradual Fed rate-cutting cycle. Domestically, this backdrop also bolsters the case for further monetary policy easing, given still-modest economic growth conditions and range-bound inflation expectations.

Locally, government finances are showing nascent signs of stabilisation but they remain an important watchpoint in our management of local currency bonds, given the strong interplay between macroeconomic conditions and government finances.

The confluence of a seemingly stabilising fiscal position and a supportive monetary policy cycle provides a favourable backdrop for nominal interest rate risk. The accrual offered by nominal bonds has anchored our investment strategy, and we continue to accumulate interest rate risk during the periodic bouts of market weakness.

We maintain a strategic preference for nominal bonds across the interest-bearing asset class, given their elevated carry and prospects for capital gains. While the inflation carry from ILBs has waned, the asset class still offers attractive medium-term returns relative to cash.

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) actively managing modified duration to maximise capital gain opportunities.    

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