Government Bonds

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.

Overall, in our view there may be some temporary volatility ahead which investors can try to sidestep or even take advantage of, but it’s probably not worth trying to be too cute as our medium term outlook is still constructive.

Given most countries are going through the same issues and their fiscal expansions are justified, the relative value has not changed that much.

Given the steep, uninterrupted rally we have witnessed since the end of March, we think it is a good time to reassess how much value is left in fixed income markets, if any.

It has been a positive sign for us that despite lockdowns being enforced in most of the major economies around the world, in the last two weeks several issuers have managed to successfully raise new debt via the primary market.

Some of the panic selling has also abated as investors are gradually building their cash piles to desirable levels. However, we are still a long way away from normal bond markets.