The picture in the bond market changed dramatically during the third quarter; as the bulls came back to aggressively see yields descended by a massive 1.8% (i.e. from 10.95% high to end quarter at 9.15%) on the RSA 2015 government paper. The short modified duration position compared to the All Bond Index benchmark, assumed towards the end of the second quarter was further aggressively covered to take advantage of the expected decline in market yields. The Credit Spreads however still widened during the quarter limiting the benefits on the Portfolio. The portfolio has increased holdings in the long end of the yield curve by switching from 3-7 years area to 7-12 years and 12+ years area. Trades included a switch from RSA 2015 paper to RSA 2026 paper.

During the third quarter of 2008 the SARB MPC decided to leave the repo rate unchanged at the August meeting. Although the outlook for inflation remained negative in the short term, global events have significantly changed the outlook in the fixed interest markets. As the global credit crisis progress with the probability of world economic recession elevated, the main drivers of inflation is unwinding with the oil price receding from $147 per barrel to below $100 per barrel, a fall of 33.0%. Food prices, which have been an Achilles heel, are also set to collapse, a precursor to lower inflation. Bond yields retreated sharply, the RSA 2015 (R153) paper yield collapsed by 1.8%, trading from a high of 10.95% at the beginning of July to close the quarter at 9.15%. The outlook for short term rates changed dramatically with the FRA curve pricing for aggressive rate cuts in the next year. Money market rates remained elevated in relation to bond yields due to the funding constraints in the banking sector, heightened by risk aversion. The 12 month NCD rate traded a high of 13.85% at the beginning of the quarter, ending the quarter at 12.50%. The bond market has seen good demand for duration with most Funds switching from cash to bonds. When the SARB MPC meets for their next interest rate meeting, we expect interest rates to be kept on hold, but a great possibility on an early cut exists. The global financial meltdown and expectations of slower global and local economic growth is overshadowing the negative inflation outlook. In this environment, with an expected lower adjustment in inflation next year makes bonds attractive.

The bond market had a torrid quarter as yields continued to ascend, accentuated by inflation data that printed higher than expected as the SARB continued hiking the repo rate, prompting market participants to remain negative. The yield on the benchmark RSA 2015 R157 bond weakened from a low 9.21%, ending the quarter at 10.715%. Credit spreads continued to widen, but at a slower pace than on previous occasions. During the quarter, the modified duration of the Fund was kept mostly shorter than that of the benchmark All Bond Index. It was only lengthened to higher than the benchmark at the end of the quarter as yields moved higher. The Funds maintained an underweight position in the long-end of the yield curve, maintaining its overweight in the 3-7 and 7-12 years sectors of the yield curve. Trades during the quarter included a liquidation of RSA 2015 paper to fund cash outflows. A switch from the RSA 2015 into RSA 2018 paper was done towards the end of the quarter to take advantage of already higher yields.

The backdrop in the fixed income markets remained negative during the quarter, on the back of elevated volatility in the currency market, with the Rand trading a wide range between R7.45 and R8.19. Money market rates also weakened, moving from 12.5% to a high of 14.05% as the market discounted further hikes in the repo rate by the SARB MPC. CPIX continued to surprise on the upside, held hostage by rampant food and energy prices. There was uncertainty regarding how much tariff increases Eskom will get from the energy regulator, which was subsequently confirmed as 27.5% on the 18th of June. As a result, Inflation is now only expected to reach the peak in August 2008. The decline in sentiment last quarter was also on the back of persistent hawkish comments from the SARB governor in his speeches, which led to further weakness in yields. The yield curve had a volatile quarter as the short end aggressively moved higher in anticipation of further hikes, and to stay in line with already elevated money market rates. Going forward, it is expected that the SARB may raise rates by another 50 basis points in August, but this is already discounted by the market, and as a result, the top in the current cycle may be getting closer. Statistics South Africa (STATSSA) announced the re-weightings of consumer inflation, which could lead to CPIX moving back inside the 6% to 3% target range by middle of 2009.

The STANLIB Bond Fund returned 3.6% for the 12 months ending December 2007, compared to a 4.2% return for the AllBond Index benchmark. During the quarter the RSA 2015 R157 bond weakened further, opening at 8.26% and closingthe year at 8.50%, there were substantial volatility in the market as trading levels touched a high of 8.70% and a low of8.05%. The yield curve further inverted when short rates were increased. The Fund maintained the bullet strategy ofoverweight in the middle sectors of the yield curve (i.e. the 3-7 years and 7-12 years sectors); The modified duration of the Fund was increased to 5.00 years, close to the All Bond Index at 5.04 years. The main trades for the quarter included the purchase of RSA 2015 R157, RSA 2014 R201, RSA 2017 R203 and RSA 2018 R204 bonds. Purchases of corporatebonds included Transnet 2027 TN27 and Investec 2013 IV04 bonds.

During the quarter the SARB MPC decided to increase the Repo rate by 100 basis points to 11.00%, after the CPIXnumbers remained above the upper band of the inflation target. The risks to inflation remain on the high side as inflationexpectations continue to rise and general pricing power are rising in the economy. The bond and money markets are stilldiverted in their outlook for interest rates. The money market pricing for higher rates, with the 12 month NCD tradingfrom 10.85% at the beginning of the fourth quarter, to end the quarter at 11.90%. The bond yield curve remainedinverted, the RSA 2010 R153 bond starting the quarter at 8.95% trading to a high of 9.58%, before closing the quarter at9.37%. The demand for short dated RSA bonds from the banking sector as liquid assets, placed a cap on rising bondyields. The outcome of the peak in inflation in 2008, will determine the probability of another rate hike from the SARBMPC.