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Guide to Bonds
InvestmentsMay 21 2020

The outlook for government bonds

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The outlook for government bonds

But those price rises mean that government bond yields fell even further, to the extent that a ten year gilt currently offers an investor an income yield of 0.2 per cent, which is vastly below the rate of inflation.

An investor who bought a ten year gilt several years ago, when the price was lower and the yield higher, are able to pocket a profit by selling that bond into the market at today’s prices, creating a situation where government bonds are providing capital gain for portfolios, rather than income.

Peter Doherty, head of fixed income investments at Sanlam says: “I think I will always have government bonds in my portfolios, but I view them as a placeholder. I own them until I find an investment I have more confidence in, rather than as a source of return.”

Government bonds rising in value

While government bonds rising in value as economic uncertainty peaks is very much part of the textbook, Mr Doherty adds that they also rose in value because central banks have been buying the assets in vast quantities.

As FTAdviser previously discussed, central banks buy government bonds at times of economic crisis as a way to increase liquidity, reduce the cost of government borrowing, and stimulate growth, a process known as quantitative easing. 

The UK may issue close to £300bn in gilts this year. That compares with about £150bn last year and a record high of £228bn in the wake of the financial crisis David Roberts, Liontrust

Mr Doherty says as a bond investor this creates a problem when it comes to deciding whether to buy government bonds, as the market is distorted by central banks who will buy at any price, and so do not care about achieving an economic return. 

But he says the advantage of the central bank’s actions, from a bond investor's point of view, is that constant central bank bond buying means one call always find a buyer, and so have some liquidity in a portfolio.

It is not just central banks that buy government bonds for reasons other than economic gain; commercial banks and insurance companies are compelled to buy them by regulators.

This is because most government bonds are classed as a “risk-free” asset, and banks and insurance companies are required to hold a portion of their capital in those.

To put those figures into context, HSBC has about £350bn of such assets on its balance sheet.

David Roberts, head of the global fixed income team at Liontrust says the actions of central banks will likely mean government bonds continue to be an asset class that has very little volatility.

He says: “Increased central bank QE programmes are designed to allow significantly greater supply without an attendant rise in yields.

"To put this in context, the UK may issue close to £300bn in gilts this year. That compares with about £150bn last year and a record high of £228bn in the wake of the financial crisis.

"However, the Bank of England’s QE programme is designed to remove up to £200bn of that from the market – with the possibility to do more.

"If we assume they are broadly happy with current market levels, then it is likely we see the volatility of core government bonds collapse in coming months, almost irrespective of economic data.”

Mr Roberts added that governments have committed to spending over £10bn on fiscal stimulus in an attempt to provoke economic growth, and if this plan works “government bonds are the last thing you would want to invest in”, but he expects such gains in economic growth to be a least a year away. 

Demand for government bonds

Bryn Jones, fixed income director at Rathbones Unit Trust Management says there has been such demand among investors that for every £1 of new bonds brought to market by governments, there are about £4 worth of orders. 

Such demand exceeding supply would typically be viewed as very positive for the price of an asset.

Alex Pelteshki, who runs the Kames Strategic Bond fund, says developed market government bonds look “decent value” right now, as economic growth and inflation are likely to be very low for a considerable period of time.

Low inflation is a positive for government bond prices as it means the income from bonds is worth relatively more.

He adds that the best value is to be found in the bonds with the longest date until maturity, as those bonds have the higher yields.

Nick Wall, bond fund manager at Merian Global Investors says there could be an element of self-fulfilling prophecy about the outlook for global growth and inflation, and the impact this has on bond markets.

He says the response to the Covid-19 crisis has left many companies, individual and countries heavily indebted, and this will restrict their ability to spend in future, limiting the capacity for economies and countries to grow. 

This is because the future debt repayments will leave less cash either for investment in future growth or for consumption today.

Low government bond yields are a reflection of the real world Guilhem Savry, Unigestion

Torcail Stewart, bond fund manager at Baillie Gifford says that while the higher debt levels, and longer-term economic issues in the UK such as the ageing population, mean the UK economy is starting to resemble that of Japan, but that bond yields, while low, have not yet reached the point where they are reflecting a “Japanese style scenario” in the UK. 

Guilhem Savry, head of macro dynamic allocation at Unigestion says: “Low government bond yields are a reflection of the real world.

"The outlook for inflation is very weak, and we may even get deflation, in which case the attractiveness of government bonds increases.

"If the Macroeconomic outlook gets worse from here, then a government bond investor will make a capital gain, while the more traditional reasons to own government bonds, the income payment and the diversification, still work.

"We prefer US government bonds as the income yield is higher right now.”