Weakest bond sale this year raises flag

South Africa’s weakest bond auction this year spells trouble for the government’s plans to reduce debt costs.

The lowest demand since December 1 raises concerns that the Treasury may struggle to finance its budget deficit in a macro environment of rising global yields and large outflows from the domestic bond market. While debt issuance is above target for this fiscal year, the government decided to keep sale amounts at current levels, reducing only the extra amount investors may buy through a non-competitive auction, further damping demand.

Adding to traders’ concerns was data on Tuesday that showed South Africa’s economy contracted the most in a century in 2020 as restrictions to curb the spread of the coronavirus pandemic ravaged output and disrupted trade.

“When the National Treasury decided to reduce the non-comp optionality but keep bond issuance the same till the end of the financial year, the market perceived this as negative news,” said Michelle Wohlberg, a Johannesburg-based fixed-income analyst at Rand Merchant Bank. “We saw how this played out in today’s auction with bid-to-cover ratios at the lowest we’ve seen this year.”

The primary dealers who buy bonds directly from the government placed orders for R11.5 billion ($749 million) of securities at Tuesday’s auction, or 1.7 times the R6.6 billion on sale. The sale took place against the backdrop of a selloff by foreign investors, with a 10th straight day of net sales on Monday bringing year-to-date outflows from the bond market to $2.4 billion.

“Although we’ve seen local real-money accounts buy bonds into weakness, it hasn’t been to the same extent that foreign selling has been,” said Wohlberg.

Yields on rand-denominated bonds rose following the debt sale. Those on notes maturing in 2040 were the least in demand at the auction and climbed a sixth day by three basis points to 11.24%. That’s the highest since November.

South Africa Reserve Bank has tempered its debt-buying program, meaning there is now less of a backstop for the country’s yields. Data released Friday showed the bank’s holdings of government securities dropped for the first time in a year, suggesting it has been less active in the secondary market.