Government Bonds

This looks to us like a buy-into-the-dip opportunity, but investors should be wary of taking on too much rate sensitivity as the move in risk-free curves is likely to persist until the rate hike cycle is actually on the way.

In the last month, global government bond curves have had a torrid time, with significant steepening seen across US Treasury, UK Gilt and German Bund yields.

From time to time, Treasury yields actually become the source of risk for financial markets.

On Wednesday, the Fed moved one step closer to tapering and even put quite a clear timeframe for it, while on Thursday, the Bank of England openly talked about rate hikes.

Our base case is for a continuation of quite high growth and a modest inflation overshoot. For bond investors, positioning for stagflation could be a dangerous trade if that base case bears out

As we rapidly descend upon the fourth quarter of this extraordinary year, we think some of the risks fixed income investors faced back in Q1 will rear their heads again before the end of 2021.

Whether the Bank of England halts all purchases in August or merely begins to slow the pace of purchasing later in Q4 this year, by 2022, less technical support will exist for gilts.

We believe UK government bonds are ultimately most vulnerable to a rise in inflation, and the 10-year Gilt currently trading at 0.73% does not come close to compensating for this.

With treasury yields moving aggressively higher this year, anyone reading or listening to the financial press will have become very accustomed to headlines highlighting the negative performance of “Bonds”.

The biggest mover so far this year in fixed income markets has been US Treasuries. The curve has bear steepened, with the short end remaining unchanged while longer maturities have sold off by anything between 10bp at the five-year point of the curve and just over 20bp in the 30-year.

The gradual backup in yields since the onset of the pandemic has given Treasuries a little more potency to protect bond portfolios, though we don’t see the rise being anywhere near big enough for them to behave like they used to.

Unlike the past six months, where nearly all new deals performed well in the secondary market, from here on in that is far from guaranteed. Expect winners and losers.