The fixed income opportunity

Governments are again living beyond their means. In the United States, spending exceeds revenue by some $2 trillion a year. One-fifth of federal income is now devoted to interest payments. South Africa faces a similar problem: public debt has risen sixfold in 15 years, while the economy has barely grown. The world has left behind the era of cheap money, but not the habits it encouraged. Portfolio Manager Farzana Bayat considers how this shift is reshaping the bond market.

The end of cheap debt

For more than a decade after the global financial crisis, borrowing was almost free. Low interest rates masked the true cost of public spending and encouraged governments to delay hard choices. Those days are over. Higher interest rates are forcing a reckoning. In the US, the bill for servicing debt now exceeds the defence budget. In South Africa, it absorbs nearly a quarter of all tax revenue before a rand reaches public services.

Markets are taking notice. In April, bond yields rose even as the dollar weakened — an unusual signal that investors are questioning America’s fiscal reliability. Across the globe the comfort of easy money has given way to the constraints of arithmetic.

The attraction of inflation protection

For investors, this backdrop has revived the appeal of inflation-linked bonds (ILBs). These bonds pay coupons that rise with the cost of living, guaranteeing a return above inflation. Real yields in South Africa are near 5% — the highest in a generation. This is a rare combination of safety and income in a world of fiscal excess.

Market expectations for future South African inflation have eased to about 3.5%. If inflation proves higher, these bonds will outperform normal bonds. If inflation trends even lower, ILBs will still deliver a secure real return of ~5%. Few assets offer such an asymmetric payoff — great returns for very little risk. They should be a core investment of all retirement portfolios.

When credit pays too little

In contrast, corporate debt markets here and abroad offer almost no extra reward for extra risk. Some South African firms now — unbelievably — borrow more cheaply than the government itself. With too much money from yield-hungry investors chasing too little issuance, credit spreads — the difference between government and corporate bond rates — have narrowed to levels that no longer compensate for risk.

Far better investment best opportunities will emerge when conditions reverse — when fear, not complacency, widens spreads and restores fundamental value to the corporate bond market. Until then, patience remains a virtue.

A cautious conclusion

High debt levels and high interest rates make fixed income investing more complex than it once was. Long-dated government bonds remain vulnerable to fiscal slippage, and corporate bonds look thinly priced. ILBs stand out as a rare opportunity: backed by the state, shielded from inflation and offering real yields unseen for decades. In a world struggling with debt, they are one of the few assets that still pay investors properly for the risks they take.