A decade of low interest rates has taken its toll on the rates of return that are achievable in the bonds market, especially on government bonds.
With high demand from investors seeking the reliability of government bonds, returns have steadily fallen to zero and then negative territory.
But while many bonds are offering a ‘double-oh’ interest rate, this is no time to die for this ever-popular asset class.
A history of low returns
Government bonds have always been relatively low yielding, but they are also generally very low risk with theoretically guaranteed returns.
However, in recent years yields have dropped so low as to enter negative territory, and with some funds committed to investing in bonds, it’s a captive market.
Over half of Europe’s current government bonds offer a negative yield. So is there still money to be made?
A return to growth?
The long-term performance of bonds depends on a number of factors, including greater geopolitical stability than has been seen in recent years.
Any kind of resolution to the ongoing Brexit turmoil would likely be good news for UK investors in the months ahead, compared with uncertainty continuing beyond 2020.
Likewise in the US, the unpredictable nature of the Trump presidency with an increase in tariffs and sanctions has hit international relations.
Some investors might be keen to see President Trump leave the White House, whether as a consequence of the impending US election campaign, or via impeachment.
But bond yields also depend on economic growth and stability, and that means that for investors, a rise in European GDP would be a welcome development in the early 2020s.
It’s been a decade of relatively lean pickings with historically low interest rates and flat growth, so investors not only in bonds, but across the board, will be hoping to see a true end to that stagnation.
What about risk?
Government bonds are favoured by risk-averse investors and in highly volatile markets, so if economies and governments stabilise, demand could fall and yields rise.
But if that does not happen, bonds – even negative yielding bonds – will continue to be the first choice for many funds that have to place their assets somewhere with minimal risk.
Even products like National Savings & Investments bonds, which have historically been good performers with government-backed security, offer just a fraction of their previous interest rates.
When each NS&I bond matures, the scheme must re-evaluate its product offerings to fairly reflect the broader market, which has seen interest rates fall by half within the space of just a few years on some products.
The bond yield curve
One useful indicator economists look to when measuring the performance of the bond market is the yield curve – essentially a ratio of yields on long-term and short-term bonds.
When long-term yields are worse than short-term yields, the curve is said to be inverted. That happened shortly before the financial crash in 2007, and has happened again recently in the US on ten-year vs two-year bond yields.
It’s a pattern that’s been noticed in the UK too, and could have some investors preparing for the worst if monetary policy is not implemented to prop up the economy in the immediate future.
With interest rates already low and government bonds offering little to no incentive for investors, the monetary policy toolkit is considerably less stocked than it was in 2007.
However, that could prove to be good news for investors, as a greater reliance on fiscal solutions to support growth could ultimately help to raise yields.
No Mr Bond, I expect you to… deal?
Returning to what we can expect from bonds in 2020, it depends on what happens with Brexit – and if it goes ahead, whether the UK leaves with a deal or not.
Johnson’s government has attempted to push through a No Deal Brexit, albeit unsuccessfully, and would be likely to keep that option ‘on the table’ if re-elected.
The inverted yield curve in recent weeks is possibly a sign that the markets are preparing for the impact of a No Deal Brexit.
Slower growth does not inevitably mean a recession; however it is generally a sign of greater risk in the investment markets.
As always, diversification is among the solutions offered by economists and investment advisors.
Diversifying helps to mitigate isolated risks – so even in a flat bond market, at least you can hedge your bets to avoid unnecessary losses due to other effects.
Disclaimer: The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.