Insight & Analysis

Bond blunders highlight importance of timing

Published: Mar 2023

Corporate treasurers need to carefully consider the merits of government bonds as an option for generating a return on spare cash.

The government bond market started the year in relatively upbeat mood with financial institutions noting the returns on some US government debt were at higher levels than at any time since the global financial crisis.

In mid-January, Fidelity International pointed to expectations that inflation would fall considerably in the coming months, leaving central banks under less pressure to slow down the economy to deal with that inflation and increasing the attractiveness of fixed income government bonds pay.

Government bonds have long been viewed as a safe investment, but valuations are based on how market expects interest rates to move – so the longer the duration of the bond, the more vulnerable it is to monetary policy.

Aggressive rate rises by central banks have taken markets by surprise over the last year. As economist and former fund manager Toby Nangle observes, ten-year UK government bond prices are about 20% lower now than at the end of 2021.

There is also the issue of accessibility. The trade-off for lending governments money for a longer period is a higher return, but corporates need to be sure they won’t need to access that cash before the bond expires. If a company tries to sell a long-term gilt or treasury before it matures and the latest version of that bond is offering a higher return, it doesn’t take Warren Buffett to work out you are looking at a sizeable loss.

This was one of the key factors in the collapse of Silicon Valley Bank, whose yields on the long-dated bonds it bought in 2022 were less than half that of a three-year US treasury note bought last week. So, when it was forced to sell these bonds early to repay depositors it took a massive financial hit that further weakened confidence.

The impact of the failure of Silicon Valley Bank extends way beyond the banking sector and is expected to persuade the Fed to change course on its interest rate policy. At the beginning of March, most analysts expected the US central bank to put up rates by 0.5% at its next meeting which, by coincidence, was yesterday. We will see if they decided upon the anticipated 0.25% increase and can we now expect the Fed to start cutting rates as early as the summer?

BlackRock – the world’s largest asset manager – is overweight short-term government bonds because it expects the coming recession to be ‘different’ in that central banks will cut interest rates to resuscitate growth. Instead, the firm believes central banks will continue with efforts to quash persistent inflation and will distinguish this from anything they have to do to shore up the banking system.

The European Central Bank did this last week by hiking rates as originally telegraphed, while BlackRock expects the Fed to take a similar approach when it holds its monetary policy meeting this week, especially as recent data suggests core inflation is not on track to drop to the Fed’s target.

“That is why we could see a reversal of the recent sharp drop in two-year and other short-term government bond yields,” says Jean Boivin, Head of the BlackRock Investment Institute. “As a result, we now prefer even shorter maturities for income in this asset class. We stay underweight long-term government bonds and upgrade inflation-linked bonds given our view inflation is likely to stay well above current market pricing.”

It is over-simplistic to suggest government bonds are not a good investment. Invesco notes government bonds play an important role in a well-diversified portfolio and their defensive qualities mean they are typically the top performer in periods of slowing growth and recession.

But like any other investment, corporates need to be aware ‘the value of your investment can go down as well as up’.

All our content is free, just register below

As we move to a new and improved digital platform all users need to create a new account. This is very simple and should only take a moment.

Already have an account? Sign In

Already a member? Sign In

This website uses cookies and asks for your personal data to enhance your browsing experience. We are committed to protecting your privacy and ensuring your data is handled in compliance with the General Data Protection Regulation (GDPR).