How safe are government bonds?

By Neil Worsley, investment strategist, Hedley & Company.

With interest rates beginning their upward move in the US and mutterings of monetary tightening in the UK and Europe there has been much attention and focus on bond markets and the pricing of these assets.

While government bonds are generally seen as a safe area in which to invest, there are some financial experts who are concerned that investors are being too sanguine over the potential risks.

Indeed, Alan Greenspan, the ex chairman of the US Federal Reserve Bank stated recently that, “When (real long-term interest rates) move higher they are likely to move reasonably fast. We are experiencing a bubble, not in stock prices but in bond prices. This is not discounted in the marketplace”.

So what are we to make of these concerns?

Today’s low yielding bond markets suggest that investors either do not believe that interest rates will rise by very much or that inflation will emerge.

There are some who also believe that in this rather ‘volatile’ world this asset class still offers the surest way to invest, after all, in a crisis this is still probably one of the safest havens.

However, what Mr. Greenspan and others worry over is that if we get accelerating economic growth across the globe with accompanying inflation then interest rates will rise much quicker than anticipated with terrible consequences for bond yields and investors capital.

There is no easy answer to this conundrum except to say that with 10 year UK government bonds yielding around 1.25% there doesn’t appear to be too much upside potential to make money, especially with inflation approaching 3% at the moment.

While Alan Greenspan’s worries may not materialise, the risks of a potential capital loss here are evident. In addition, for those who believe in a Corbyn led government, then this would present an additional risk to gilts if the Labour Party were to implement their promised ‘reforms’, with a severe negative impact on prices.

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