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Momentum Bullish on CPI-Linked Bonds as Inflation Accelerates

Momentum Investments is bullish on South Africa’s inflation-linked bonds, betting the notes will outperform fixed-rate debt this year as consumer prices in Africa’s biggest economy continue to rise.

“Inflation-linked bonds are currently in a perfect storm, where rising inflation and declining real yields generate substantial returns,” Conrad Wood, who oversees 70 billion rand ($8.4 billion) as head of fixed-income investments at Momentum, said in a presentation to investors in Cape Town. “This environment is likely to persist over the current year.”

The inflation rate slowed to 6 percent in March. Linkers, as the securities are known, will probably return 8 percent this year, Wood said. That compares with a projected return of 6 percent for fixed-rate bonds, according to Momentum’s projections. Inflation will probably accelerate as energy and food prices rise, Wood said. Momentum sees the inflation rate rising to 6.1 percent by the end of 2012.

The central bank forecasts inflation will remain close to the top end of its 3 percent to 6 percent target range this year. The bank has left its benchmark repo rate at 5.5 percent since Nov. 2010 to aid growth. Rates are unlikely to rise before the third quarter of 2013 as the central bank continues to ignore inflation in favour of growth, Wood said.

The yield on 2.5 percent inflation-linked bonds due 2017 dropped 24 basis points, or 0.24 percentage point, to a record low of 0.62 percent on April 24. The notes yielded 0.7 percent today, unchanged from yesterday’s close.

Inflation-linked debt pays interest on a principal amount indexed to the consumer price index. When inflation accelerates, the securities pay more interest.

Linkers have returned 4.2 percent this year, compared with the 4.1 percent return for fixed-rate bonds, according to Bank of America Merrill Lynch indexes.

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