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Is now the time to buy government bonds?

We might be at or near peak interest rates, and US treasury supply is impacting bond prices. With that in mind, we look at the appeal of government bonds in the current market.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

Without hindsight, you can never be sure exactly when interest rates have hit their peak. While this is usually true, it feels reasonable to say that if we aren’t at the peak right now, we’re close to it.

Both the Bank of England (BoE) and the Federal Reserve (Fed) have kept rates at the same level in their last two meetings, having previously increased rates 14 and 11 times in a row respectively.

These rate hikes have caused government bond yields to rise, with the 10-year US treasury yield recently topping 5% (its highest since 2007) and 10-year UK gilts consistently yielding 4.2 – 4.7% over the last few months.

Just because the BoE and Fed haven’t increased rates at their last two meetings, doesn’t mean that rates won’t go up again from here.

Particularly in the US where the economy seems to be running hotter than the Fed was expecting. That could mean inflation stops decreasing or even starts to increase again, which would encourage the Fed to raise rates again.

In the UK, things aren’t looking so good in terms of economic data, and inflation isn’t falling quickly anymore. If inflation remains at current levels, this might also encourage the BoE to raise rates.

Where next for interest rates? – 8 things investors need to watch out for

This article isn’t personal advice. All investments and any income they produce will rise and fall in value, meaning you could get back less than you invest. If you’re not sure if an investment is right for you, ask for financial advice.

Investing in individual gilts isn’t right for everyone, you should only invest in gilts as part of a diversified portfolio.

Why do interest rates matter for government bonds?

Government bond yields have to increase when interest rates increase, or they lose their investment appeal.

When bond yields increase, their prices fall and government bonds have lost a lot of value since the start of 2022. As an example, the average total return of the IA UK Gilts sector from 31 December 2021 to 31 October 2023 has been -27.61%.

We’ve seen rates rocket from near zero to 5%. While it’s unclear where they’ll go from here, it feels unlikely that we’ll see a repeat of that sort of increase and get to 10%.

Once interest rates peak, the headwind to bond performance will have ended, for this cycle at least. That means when looking ahead, investors could potentially see more ‘normalised’ bond returns, meaning bond returns, over the short to medium term, that are broadly in line with their yields.

There’s also the potential of future interest rate cuts, which would be a tailwind for bond performance instead of a headwind. This adds to the appeal of bonds. But there are no guarantees here. We could see rates remain stable for a while before starting to rise again.

Supply and demand are key to bond prices

As those of us who studied economics at school will remember, prices are determined by supply and demand. While bond pricing is complex and impacted by many variables, supply and demand are still the key factors in determining bond prices.

Bond markets have been worried about the supply of US treasuries recently. Particularly since August when the US confirmed how much it planned to increase the amount of bonds they were issuing to the market.

This increased supply caused prices to fall further (and remember that yields and prices move in opposite directions, so yields increased).

However, the US treasury department recently confirmed that while it will continue to issue more debt than it has in the past, the level of increases are going to be lower than expected.

The impact of this was that US treasury prices increased (and so yields fell a bit).

There’s an argument then, that the concerns over US treasury supply are easing, for the time being at least. This is good for bond markets around the world as this has been another headwind for bonds recently, which is potentially now subsiding.

US treasuries are effectively the barometer that investors use to price all bonds. So, changes in their value usually result in changes in value of other bonds too.

How have gilts been affected?

Coming back to the UK, gilts have been on a slightly different journey to US treasuries, largely due to the ill-fated mini budget of 2022.

That episode caused a fall in gilt prices and for investors to consider the potential impact of the increased supply of gilts earlier than they have for US treasuries.

The result’s been that the 10-year UK gilt yield has traded at around 4.4% since early June. While there’s been some volatility, the previous upward trend has stalled.

This is a positive for gilt investors, as it shows at least a little bit of stability. Of course, whether this will continue is a different question. But, with monetary policy and gilt supply seemingly well telegraphed to the market, there are few obvious additional headwinds facing gilts right now.

As a UK investor, another important point about investing in individual gilts is that you’re not charged capital gains tax on any profits that come from price changes. Remember though, this won’t apply to any gains from a bond fund that invests in gilts.

Find out what you need to know about buying gilts

Tax rules can change, and benefits depend on your individual circumstances.

What does all this mean for investors?

We have a government bond market that’s currently providing yields higher than they’ve been for years. You‘re being paid to hold bonds, regardless of whether there’s any change in bond value.

And some of the headwinds that have caused notable losses in bonds since the start of 2022 seem to be subsiding.

Has there been a better time to buy bonds in the last ten years?

Possibly. Possibly not. Only time will tell on that. But even if it isn’t the best time to buy them, it feels unlikely that this would be a really bad time to buy.

Learn more about bonds and gilts

See latest gilt prices

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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