Having started to rise in early December, government bond (gilt) yields have continued their march upwards so far in 2025.
With government borrowing costs soaring, the 10-year government bond yield has climbed to its highest since the great financial crisis in 2008.
But what does this mean for investors and what could be next for government bonds from here?
This article isn’t personal advice. Remember, investments and any income from them can rise and fall in value, so you could get back less than you invest. Yields are variable and past performance isn’t a guide to the future. If you’re not sure if an investment’s right for you, ask for financial advice.
Why are gilt yields rising?
There are a few factors all coming together which are causing gilt yields to rise, or their prices to fall, depending on which way you look at it – gilt yields and prices move in opposite directions.
One reason is the impact of the 2024 Autumn Budget on future government borrowing expectations – these have broadly increased. This means the government will have to borrow more and the way the government borrows is by issuing gilts.
My A-level economics textbook was clear – when supply increases, prices fall. And when gilt prices fall, their yields increase.
Low growth in the UK also isn’t helping. Gross domestic product (GDP) figures from the third quarter and October 2024 were weak and effectively show no growth in the UK. Should this continue, it will add to the potential need for higher government borrowing in future.
Inflation is also proving frustratingly sticky in the UK, with wage growth remaining high. This is adding to worries that inflation might not actually come down to target in 2025.
The latest consumer price inflation (CPI) figure from November was 2.6% in the UK, up from 2.3% in October, although this was in-line with expectations.
It's not just a UK issue though.
Treasury yields have also been on the rise in the US, with Donald Trump and a strong economy having an impact there.
The uncertainty around what potential policies Trump could enact in 2025 is causing jitters in markets. There’s broad consensus that his policies around tariffs could be inflationary, but some of his other pro-growth policies could also be inflationary.
At the same time, the US economy is running hotter than many predicted. Job vacancies were much higher than forecast last week, suggesting companies are struggling to hire new workers. There’s more data to come which could make things worse.
This has meant market predictions of interest rate cuts from the Federal Reserve (Fed) have reduced, with current expectations showing potentially only one 0.25% cut in 2025.
This is because if inflation remains higher than target, it becomes harder for the Fed to reduce interest rates. And if the economy is already growing nicely, the need to cut rates to encourage growth is lower.
What does it mean for investors?
Well firstly, investors who own gilts will likely have experienced losses since the start of December.
Remember though, if an investor owns a specific gilt directly and holds it to maturity, these fluctuations in price are just that, fluctuations.
The return over the period from purchase to maturity will remain the same (assuming the UK government doesn’t default on their bond payments).
The bigger question is probably whether this makes gilts more or less attractive as an investment right now.
Positives first. If you invest in gilts today, the price you’re paying is lower than it was at the start of December. Returns for most gilts are fixed, so this means the return today is more than it was – or rather, the yield is higher.
For bonds that are due to mature in the short to medium term, this feels quite attractive.
At the start of December 2024, the yield on a five-year gilt was around 4.1%. That means an investor who bought a five-year gilt at that time and held for the full five years until maturity would’ve received 4.1% annualised over that period.
If you buy a five-year gilt today, you’re going to get a yield nearer 4.6%. That’s a meaningful increase for what’s essentially the same investment. Hence, it feels more attractive than it was at the start of December.
But it’s not all good news.
It’s quite possible that interest rates will remain higher than previously expected, meaning investors would get a higher return on cash held at the bank. So, on a relative basis, there might not be much difference. And cash doesn’t fluctuate in value.
It’s also possible that yields will continue to rise from here.
So, investors might be tempted to wait for potentially higher returns. But trying to time when yields peak is going to be extremely difficult, meaning that could backfire if yields suddenly reverse their current trend.
Overall, volatility should be expected, especially over the short term. That means it might be better to think about investing in bonds more widely rather than just gilts.
Bond funds are a great way to get access to a mix of government and corporate bonds, which could also have less ups and downs than individual gilts. However, because fund managers buy and sell bonds within the fund without always holding them to maturity, investors could get back less than they invest.
3 fund ideas to invest in bonds
Investing in these funds isn’t right for everyone. Investors should only invest if the fund’s objectives are aligned with their own, and there’s a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.
For more details on each fund and its risks, use the links to their factsheets and key investor information.
Invesco Tactical Bond
The fund is co-managed by Stuart Edwards and Julien Eberhardt who have been part of the fixed income team at Invesco for well over a decade.
Over the long term the aim is to deliver a total return, through the combination of growing capital and income, rather than focusing purely on generating a high income.
The managers can invest in all types of bonds, with few constraints. This includes high yield bonds and derivatives, both of which can add risk if used.
The performance of the fund hinges on their ability to interpret the bigger economic picture, and they can tweak the fund's investments based on what they see. They aim to shelter the fund when they see tough times ahead, and seek strong returns as more opportunities become available.
We think this is a good fund for exposure to the wider bond market. It takes away the hassle of deciding which type of bonds to invest in, and when, because the managers are given the discretion to make these decisions for you.
Artemis High Income
The fund is co-managed by David Ennett and Jack Holmes. It focuses on paying a high income to investors, by mainly investing in bonds, but with some investments in UK and European shares too.
Ed Legget, an equity specialist, helps the managers to select the shares for the fund.
While the fund can invest in all types of bonds, the focus on providing a high income means they have bias towards high yield bonds. The managers focus on those companies which they believe have the ability to pay their debts. But, this is a higher-risk approach due to the greater potential for the bond issuers to default on their payments.
The managers can also use derivatives, which adds risk if used.
We think this is a good fund to diversify a more conservative bond portfolio or a portfolio focused on shares. The focus on income means it could be suitable as a more adventurous part of an income portfolio too.
Charges can be taken from capital, which can increase the yield but reduces the potential for capital growth.
Royal London Corporate Bond
The fund is co-managed by Shalin Shah and Matthew Franklin and focuses on investment grade corporate bonds – higher quality bonds issued by companies. They also invest some of the fund in high yield bonds, which adds risk.
We think the team’s edge comes from their detailed research into low-profile parts of the market. These under-researched bonds might be unrated (their credit quality hasn’t been assessed by a credit ratings agency), complex and often secured against a company’s assets.
This detailed research gives the managers the ability to uncover some better investment opportunities within this specific area of the bond market.
However, these types of bonds can be higher risk and harder to trade, particularly in a falling market. Because of this, the investment journey might be more volatile than some peers. For this reason we think it could work well as part of an investment portfolio invested for income, focused on the long term.
Charges can be taken from capital, which can increase the yield but reduces the potential for capital growth.
Annual percentage growth
Dec 2019 - Dec 2020 | Dec 2020 - Dec 2021 | Dec 2021 - Dec 2022 | Dec 2022 - Dec 2023 | Dec 2023 - Dec 2024 | |
|---|---|---|---|---|---|
Invesco Tactical Bond | 12.93% | 1.59% | -4.64% | 6.46% | 1.55% |
Artemis High Income | 1.73% | 5.92% | -10.12% | 10.92% | 10.03% |
IA Sterling Strategic Bond | 6.05% | 1.02% | -11.73% | 8.13% | 4.63% |
Royal London Corporate Bond | 8.23% | 1.03% | -16.07% | 11.58% | 5.10% |
IA Sterling Corporate Bond | 7.75% | -1.90% | -16.39% | 9.22% | 2.70% |