Martin Harvey, fixed income portfolio manager at Wellington Management, looks at why developed-market government bonds are becoming more attractive again after years of low yields.
For years, investors had little reason to get excited about developed-market government bonds: they offered little yield, which also meant little downside protection when equities underperformed. Four years on, we think this has now fundamentally changed. Global treasury bond yields are just shy of 4%, their highest level since 2007 and above peaks reached during the 2022–23 sell-off. After a sudden, generational repricing, we believe sovereign debt once again offers meaningful income, potential capital gains and a credible role in adding diversification to portfolios.
The appeal goes beyond headline yields. Across the G10, the average five-year bond yields more than one percentage point above prevailing policy rates. That kind of term premium is more commonly associated with the beginning of a tightening cycle, not the moment when average policy rates are already close to 3%. What this means is that investors are being paid well to extend duration: you are receiving income while embedding downside protection, should the economy suddenly slow down.
We need to acknowledge why yields have moved up so much and not be blinded by unrestrained optimism surrounding high-quality bonds. Markets have lifted their estimate of neutral rates dramatically. Strong nominal growth, still running around 5.5–6%, is not expected to slow down meaningfully. Add to this commodity pressures linked to Middle East tensions and we could see inflation (and therefore bond yields) higher for longer.
Bonds also seem to have lost some of their traditional defensive power, at least in periods of higher inflation. Since March, equity weakness has often coincided with rising rather than falling yields, as inflation fears replaced AI-driven risk concerns earlier in the year. Until energy prices ease, the familiar stock-bond hedge may remain unreliable.
Despite the headlines, we don’t think fiscal risks have been the real driver of the sell-off: with swap spreads and term premia relatively stable, we are yet to see a test of demand for bonds coming from a combination of heavy sovereign borrowing, rising debt-service costs and AI-related issuance, particularly at the long end.
Japan may offer an early signal. With 10-year and 30-year yields near 3% and 4%, respectively, the case for shorting Japanese bonds has weakened. If Japanese yields stabilise, global markets may follow. We think the opportunity is compelling, but patience is essential. The best entry point may arrive when growth, energy prices or inflation start turning lower, as that’s when we expect to see the greater opportunity for dispersion across markets, sectors and issuers.