Yields on sovereign bonds have risen steeply over the past few months even as global central banks have cut rates. While such a phenomenon is unusual in a rate-cutting cycle, it shows how investors have sharply repriced their growth and interest rate outlook for the coming years.
The US Federal Reserve (Fed) has cut the key policy rates by 100 basis points since September, as officials turned their attention to the jobs market after curtailing the post-Covid spike in inflation. Market expectations for Federal Funds Rate1 as of the end of 2026 have risen from 2.5% in mid-September to around 3.7% now, indicating that markets are expecting just two additional rate cuts in the current cycle.
Developed market bond yields rise sharply
US 10-year Treasury yields are hovering near the highest level since the Global Financial Crisis (GFC), with similar moves observed for sovereign bonds of other developed markets. Regardless, we believe that current nominal yields offer attractive compensation for any uncertainty around inflation, elevated neutral rates in a post-COVID world or risks around duration.
If winter comes, can spring be far behind?
The last three years have been the worst stretch for bonds in 180 years, as central banks ramped up interest rates from near zero to tackle a spike in inflation caused by a mix of pandemic era supply-chain constraints and pent-up demand. This sudden U-turn caused a lot of pain for investors, as there was little cushion from coupon (periodic interest payment made to the holder of a bond) income even as bond prices plummeted.
Rolling three-year US long-term nominal (Before Inflation) bond total returns
The bond markets bore the brunt due to the rise in yields stemming from the most aggressive tightening cycle in decades.
Looking back to the early 1800s for similar stretches of bond market weakness, this has lasted only two to three years and has been followed by large positive, total return2 years.
Importantly, we believe that the coupon income generated by investing in sovereign bonds provides an adequate buffer against any capital losses due to further yield increases.
Stocks, bond correlation
It's also worth bearing in mind that earnings yield3 on US equities have plummeted, making US stocks the most unattractive in a long time, while bonds look the cheapest they have been in the last 20 years.
Moreover, it’s generally assumed that bonds and stocks are negatively correlated, which is the basis for the 60:40 portfolio concept, where 60% is invested in stocks and 40% in bonds. While this was true for most of the period in the current millennium, this correlation has turned positive since September 2022.
We believe that one could consider bonds as an attractive standalone investment, moving away from the sole focus on their diversifying properties.
How about corporate bonds? While the yield levels on such bonds are attractive too at this juncture, we believe credit spreads are too tight on a historical basis, which makes them risky investments. That boosts the haven appeal of sovereign bonds.
Overall, we believe investments in sovereign bonds could potentially provide positive outcomes for investors in a wide variety of economic or market outcomes, and not only as part of a multi-asset portfolio. To generate alpha (excess return on an investment relative to the return of a benchmark) in a sovereign bond fund, the duration4 as well as the contributors are important. The divergence in economic cycles between different countries and regions, and the resultant dispersion in bond yields, provides an opportunity for investors to boost returns through active country selection.
Jupiter Global Government Bond Active UCITS ETF, which aims to outperform traditional sovereign bond investments by offering a diversified portfolio of developed and emerging market government debt, provides an opportunity for investors to consider investments in bonds as a standalone asset class. With their complexity, potential for market inefficiencies, and sensitivity to macroeconomic factors, we believe Global Sovereign Bonds are an ideal asset class for an active ETF.
Footnotes
1The rate at which banks and other entities lend or borrow from each other overnight
2Gains made from income and appreciation of a bond over a specified period
3A metric derived by dividing earnings per share for the most recent 12-month period by the current price per share
4A measure of the sensitivity of the price of bond to a change in interest rates
Fund specific Risks
- Currency (FX) Risk - The Fund can be exposed to different currencies and movements in foreign exchange rates can cause the value of investments to fall as well as rise.
- Share Class Hedging Risk - The share class hedging process can cause the value of investments to fall due to market movements, rebalancing considerations and, in extreme circumstances, default by the counterparty providing the hedging contract.
- Interest Rate Risk - The fund can invest in assets whose value is sensitive to changes in interest rates (for example bonds) meaning that the value of these investments may fluctuate significantly with movement in interest rates e.g. the value of a bond tends to decrease when interest rates rise.
- Pricing Risk - Price movements in financial assets mean the value of assets can fall as well as rise, with this risk typically amplified in more volatile market conditions.
- Emerging Markets Risk - Emerging markets are potentially associated with higher levels of political risk and lower levels of legal protection relative to developed markets. These attributes may negatively impact asset prices.
- Contingent convertible bonds - The fund may invest in contingent convertible bonds. These instruments may experience material losses based on certain trigger events. Specifically these triggers may result in a partial or total loss of value, or the investments may be converted into equity, both of which are likely to entail significant losses.
- Credit Risk - The issuer of a bond or a similar investment within the fund may not pay income or repay capital to the Fund when due.
- Derivative risk - the Fund may use derivatives to generate returns and/or to reduce costs and the overall risk of the Fund. Using derivatives can involve a higher level of risk. A small movement in the price of an underlying investment may result in a disproportionately large movement in the price of the derivative investment.
- Counterparty Default Risk - The risk of losses due to the default of a counterparty on a derivatives contract or a custodian that is safeguarding the fund's assets.
- Sub investment grade bonds - The fund may invest a significant portion of its assets in securities which are those rated below investment grade by a credit rating agency. They are considered to have a greater risk of loss of capital or failing to meet their income payment obligations than higher rated investment grade bonds
The value of active minds: independent thinking
A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.
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This material is for informational purposes only and is not investment advice. Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested.
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