This article was originally published on ETFTrends.com.
A falling local currency in conjunction with rising government debt yields are bringing South African bonds to the brink of junk status as the likelihood of a credit rating downgrade increased as the country's lawmakers expect wider budget deficits and lower growth forecasts.
Additionally, Finance Minister Tito Mboweni said government debt will peak within two years and be higher than initially expected, while state revenue languishes.
"We are trying to make the best out of a difficult situation," Mboweni told reporters prior to his budget speech to parliament.
This news won't do South Africa any favors once it reaches the ears of credit rating companies like Moody’s Investors Service. Moody's, one of the few firms that rates South African debt, has already delayed reviewing the country’s debt rating just earlier this month.
“South Africa remains stuck in a low-growth, high-debt environment and it is difficult to get euphoric about the outlook for the rand,” said Bernd Berg, a foreign-exchange strategist at Woodman Asset Management AG in Zug, Switzerland. “With little positive domestic drivers and a challenging external environment, it is hard to see the rand outperform its emerging-market peers in the short run.”
A downgrade could certainly ignite a sell-off, sending yields higher and bond prices lower. Yields are continuing a rapid ascent to 9.5% after touching just below 8% prior to April.
“I was clearly too optimistic that Mboweni would announce enough fiscal tightening to keep the ratings agencies at bay,” said Win Thin, global currency strategist at Brown Brothers Harriman and Co. “I think risks of downgrades have gone up significantly.”
According to Bloomberg, foreign investment in South African bonds total 38%, which would cause a major depression in bond prices should a sell-off occur.
Related: South Africa ETF’s Woes Can Continue
U.S. Investors Pile in on Floating Rates and Short Duration
In the U.S. capital markets, volatility continued its reign as the Dow Jones Industrial Average fluxed and then fell over 200 points as of 1:30 p.m. ET. In the fixed-income space, Brian Gilman of Virtu Financial saw increased activity in floating rate exchange-traded fund (ETF) names like the iShares Floating Rate Bond ETF (FLOT) .
FLOT seeks to track the investment results of the Bloomberg Barclays US Floating Rate Note < 5 Years Index (the "underlying index"), which measures the performance of U.S. dollar-denominated, investment-grade floating rate notes. FLOT invests in the component securities of the underlying index and may invest up to 10% of its assets in certain futures, options and swap contracts, cash and cash equivalents, as well as in securities not included in the underlying index.
"Floating rate names remained active with flows more two-sided than they have been," said Gilman.
For more trends in fixed income, visit the Fixed Income Channel.
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