How have government bonds performed
In 2022, 10-year UK Government Bond Yields have moved from about 1 % to, currently, circa 4.35 %. In price terms, this means that the Gilt 1 % 2032 has moved from 100 to 74, or – 26 % in 9 months.
In even more stark terms, anyone holding that bond in the last 9 months has seen a mark to market loss in nominal terms that will never be made back by the income in the life of the bond.
Finally, remember that Gilts and other government bonds are a key pillar in the financial system, where they are classified as “risk-free”!
Similarly, fixed income credit markets where companies borrow, have had a torrid year to date. 10-year bonds from companies such as Vodafone and Marks and Spencer have seen falls of more than 30 % this year.
This remarkable very negative turnaround for UK bond markets has, in part, been driven by extraordinary global macroeconomic and geo-political events, but importantly the cocktail only very recently became toxic with the introduction of poorly thought-out populist economic policies delivered by Liz Truss and Kwasi Kwarteng in September.
Does the financial market have confidence in UK bonds?
Financial markets place a lot of emphasis on “confidence” which really is a catch all term covering trust, believability, and credibility. Nobody is perfect and so investors have to make judgment calls on how realistic and sensible Government policies are and will be and how a Central Bank will protect the value of a currency to the extent it can. If one group is negative on a country and sells risk, another group that is more positive may buy that risk. Depending on the price of the risk and available return from the asset, one side will probably be happier with the decision than the other over time. It all depends on risk appetite, what the alternatives are and what the objectives are.
Put simply, it took only an hour on Friday September 23rd or so for a high percentage of investors globally to concur that the policies proposed by the UK Prime Minister and Chancellor both lacked credibility and put UK financial stability at risk in a big enough way to matter. Confidence is not only about the numbers – it includes an assessment of the tone and the thinking behind the policies which then generate the numbers. Truss and Kwarteng got a big thumbs down!
What to do from here
In recent years I have been a consistent critic of QE (Central Bank debt buying) and ultra-low interest rate policies because of the false impression given to investors about the level of risk in certain assets. “Moral Hazard” is where an apparently benign third party takes away the downside risk of an activity in order to encourage more of that behaviour. As a philosophy this is not a bad way to start something, but it’s an awful way to go on. And on. And on. Which is what happened with QE and low rates.
So, ironically there is a bright spot in the current dark environment. For the first time in at least five years and probably more like a decade, investors in £ bonds are getting paid handsomely to take risk. Obviously, there are a lot of factors to consider when buy a bond or bond fund but as a guide, bonds with medium term maturity dates from high quality secure businesses are offering yields in the mid to high single digits. Examples include United Utilities 2035 (6%) British Telecom 2028 (7%) and Virgin Media 2031 (9 %)
If you are ultra-cautious and want inflation protection, UK Index Linked Government Bonds now offer a small positive return of about 0.5 – 1 % after inflation, something not seen since circa 2008 / 9 in the global financial crisis. “Plus ca change” !
Past performance is not a guide to future performance.
The value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital.