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After the Government of National Unity (GNU) was formed in June 2024, risk was essentially priced out of South Africa’s bond market. But the circumstances then and now are very different in seven key respects.

What is a risk event? A risk event is a domestic political or related economic development that increases the risk of holding the assets of any particular country. The extent to which risk is present in an economy can be measured in a number. That number is called the yield differential. This measures the difference between the country in question’s 10-year bond yields and the yield on 10-year American bonds. American bonds are seen as relatively safe, so the differential measures the “compensation” that investors demand for holding assets outside of the United States (US). The higher the yield differential, the higher the compensation demanded, which reflects the relative risk assigned to an economy.

The chart below shows the yield differential for South Africa and the 10-year US yield.

Note how spikes in the differential accord at the moment of major crises. The September 1998 spike shows the effects of the Asian financial crisis as investors took flight from emerging markets. The December 2007 spike aligns with president Thabo Mbeki’s defeat by Jacob Zuma. The 2012 spike aligns with a downgrade of South African bonds and a negative economic outlook from ratings agencies. In December 2015, the differential spiked after Nhlanhla Nene was replaced by Des van Rooyen as finance minister. And the sharp spike in March 2020 aligns with the Covid-19 pandemic and the credit ratings downgrade that followed.

After 2020, the differential closes as the country recovers from the pandemic and then, following the formation of the GNU, the differential closes sharply, falling all the way to the level it last held between 2004 and 2007, when Mbeki was in charge and GDP growth was over 5%.

What that means is that risk was almost completely priced out of the South African market by investors – they will always demand some compensation for holding South African bonds but what they demanded post-May 2024 was on par with what they demanded during the relative stability of the Mbeki years, and the high rate of economic growth in the latter part of that era. An era that saw a budget surplus among other things!

The question now is whether the upcoming local government elections (LGEs), due to be held in November, will change any of that and, if so, in what direction?

A prevailing investor community view is that the African National Congress (ANC) will lose further support as the Democratic Alliance (DA) strengthens, and the GNU holds, and that all of this is net positive for South Africa. The investor view is that the ANC is a problem for the country, the DA getting stronger is part of the solution, and the GNU is essential to the success of that solution.

To a certain extent, on the surface at least, this sense of the LGE result is right and, if the broader narrative around it holds, then the bond market should hold up too.

However, many of the conditions around the 2026 LGEs are very different to what they were in May 2024, and that this reality is starting to sit at odds with where the market narrative is at on the GNU. Narratives can, of course, be much stronger than reality and may hold out at odds with realities, but the risk is that, when the narrative eventually catches up to the reality, or if a shock event forces that, then the yield differential may open suddenly and, for many participants, unexpectedly.

Specifically, there are seven issues that are of concern.

1. In practice, the local government election results will be chaotic, and there will be over 100 councils where no party wins a majority. And there is no broad pact between the ANC and the DA in place to address that, as there was before the 2024 elections.
2. The current DA leadership is prepared to walk away from the GNU, unlike that of pre-May 2024, which was deeply invested in making the GNU a success.
3. The ANC leadership near President Cyril Ramaphosa now prefers a minority government solution and thinks the GNU was a mistake.
4. The ANC is coming apart as the uMkhonto weSizwe Party grows, support for the Economic Freedom Fighters is holding, that party has joined the Gauteng ANC in an alternative GNU there, and the South African Communist Party seeks to go it alone, while the basic administrative management of Luthuli House has weakened further, as the failure to submit all of its election candidates attests.
5. South Africa is set to double down against the US, and the US has moved to sanction South Africa, albeit in a modest sense, but it may escalate that to something much more serious.
6. Ramaphosa was still a fairly strong figure in May 2024. He is now greatly weakened, as a consequence of Phala Phala, with polls showing a sharp decline in his popularity. And he is increasingly a lame duck, given that his term as leader of the ANC expires in December 2027.
7. There is no firm indication of who may succeed Ramaphosa. That is new - the first time in over 50 years that the answer to who will lead the ANC next is essentially unknown.

Will the market view hold under those seven circumstances?

The answer is a tentative yes, at least initially, as long as the national GNU holds and Ramaphosa remains in office through 2027, and is then succeeded by a pragmatic figure. But if any of that is shaken, the narrative may begin to turn, and as it does so, yields will lift. That means that South Africa is now in a very different place strategically, from an investor perspective, than where it has been over the past 24 months.

The circumstances and events of post-May 2024 deservedly saw risk priced out of South Africa. But the circumstances now are very different, and while the narrative may, of course, hold up against that for a time, if the narrative breaks, then risk comes flooding back into the bond market at perhaps near unprecedented levels.