The power of bonds – why are yields rising?

Just like their equity counterparts, government bond markets have also experienced a volatile year so far. Continued government spending, sticky inflation and hawkish central bank outlooks have caused yields to fluctuate.

Raising debt is fundamental for governments to fund public spending. Just like any other loan, these bonds come with an interest rate (yield) to offer the lender or investor a return on their capital. Government bonds are typically viewed as less risky and therefore the yields for these bonds are lower than high yield corporate bonds.

More recently, investors have been demanding more compensation for funding the deficits of governments who are regularly raising their debt levels. As yields go up, bond prices go down as existing bonds with a lower yield become less desirable.

Past performance should not be taken as a guide to future performance. The value of investments, and the income from them, can fall as well as rise and you may not get back what you put in. You should continue to hold cash for your short-term needs.

The US has been put under the microscope ever since President Donald Trump began his second term in the White House. A key priority of Trump’s manifesto was tax cuts. Taxes are a key financer of government spending, and so cutting existing taxes will reduce its income.

In May, the Senate passed Trump’s sweeping tax and spending bill which could add nearly $4 trillion to US debt over the next 10 years – something bond investors are not eager to continue funding.

Additionally, Trump’s tariffs announced in April could have a knock-on effect on inflation and cause rising prices to reaccelerate again – another risk bond investors are wary of. Following ‘Liberation Day’, 10-year US Treasury yields – US government bonds – spiked from less than 4% to around 4.5% where it has been hovering ever since. 

Japan’s scenario is slightly different. Japanese government bond (JGB) yields have been rising as its central bank has been unwinding a decade-long loose monetary policy. While most developed economies are fully submerged in a rate cutting cycle, the Bank of Japan (BoJ) has been gradually raising interest rates since last year, resulting in yields rising.

Furthermore, weak investor appetite for these long-dated bonds has meant yields have been pushed up even further to gather more demand. As a result, JGB yields for long-dated bonds are the highest they’ve been for over 20 years. 

• Improving expected returns: Despite their recent volatility, US bond yields remain within the same range they’ve been trading in for the past two years – albeit at the higher end of the scale. Long-term expected returns are improving however we foresee further yield volatility given the higher structural fiscal deficit by the US government.
• Risk and reward is a balancing act: We’ve had minimal exposure to JGBs for the past two years as the BoJ has been in a rate hiking cycle. Yields have been rising over this time meaning bonds prices fell. More recently, the risk-reward expectations for JGBs are becoming more balanced given that yields are higher and their valuations are more attractive.
• Time to selectively increase exposure: Our process has guided us to favour equities over bonds in recent years. However, given the strong rebound in markets following April’s weakness, we’ve taken the opportunity to adjust our allocation by slightly reducing our overweight position in global equities in favour of JGBs. While we still prefer global equities over bonds in a typical balanced portfolio, our outlook on JGBs has improved. 

Government bonds may continue to experience periods of volatility, especially as investors become cautious about excessive government debt levels. But they are a fundamental diversifier for our equity allocation and offer downside protection if economic growth were to deteriorate.

In order to diversify risk further and to complement other defensive assets like bonds, we have an allocation to a liquid alternatives fund. Its minimal correlation with either equity or bond market has provided valuable diversification this year to our multi-asset portfolios, even whilst bond markets have endured increased volatility in recent months.