What goes up must come up down, or so it often seems when we talk about government bond yields. The first full week of July saw yields on 10-year US Treasuries move to their lowest levels since February, with similar action in the UK gilt market. This stands in stark contrast to the big rise we saw in the first quarter of this year, when inflation concerns appeared to fluster bond investors.
With yields moving inversely to prices, this recent fall boosts performance for classic 60/40 equity and bond portfolios. It also confounds long-running doubts about government bonds once again.
It’s equally notable that bonds have remained fairly popular among UK investors this year, despite inflation concerns. Investment Association figures show that fixed-income funds took in nearly £7bn on a net basis in the first five months of 2021, outpacing the net inflow of around £6bn for equity funds.
But if government bonds are looking more comfortable, investors should think about what the latest moves tell us. Explaining market activity can be speculative at best, but one theory suggests investors are simply less worried about inflation. If true (not all agree), one risk is that this threat is now being underestimated.
Another explanation goes that investors have tempered their expectations for economic growth. That could be bad news for equity returns and the cyclical stocks that have recently prospered.
Technical market factors could also be at play. But if growth were to falter, the drop in yields could be a case of "good news, bad news".
