Bond Watch: are rising ‘long’ bond yields an opportunity?

One of the biggest bond market trends over the past year has been a steepening of the yield curve, which just means that yields on bonds maturing in a long time have risen more than those maturing soon.

This means that when you buy a bond maturing in 30 years’ time, investors are now getting a significant excess yield over a bond maturing in just a couple of years.

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For example, the 30-year UK gilt now yields 5.4%, compared with just 4% for one maturing in two years. A year ago it paid 4.8% compared with 4.45% for a two-year gilt.

This has been a trend in the US too, where investors have also put a discount on holding longer US government bonds, known as Treasuries.

It makes sense that longer bonds pay more, known as the “term premium” in market-speak. This is because longer bonds carry more risk, as market conditions could change significantly over the life of the bond.

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For example, rising inflation or interest rates could wipe out its value, but a bond maturing in just a couple of years is a sure bet as you know what you will be paid if you hold it to maturity.

So, why are investors selling longer bonds but not shorter bonds? Much of it boils down to worries about rising government spending and how they are going to fund it.

Peter Spiller, manager of Capital Gearing Ord (LSE:CGT) investment trust, says bond markets are beginning to show strain in the face of excessive government deficits.

He notes: “While it was central to US Treasury secretary Scott Bessent’s economic strategy that the fiscal deficit be reduced to 3% of GDP, neither the current fiscal plans nor the growth prospects for the US economy suggest that this is likely to be achievable.

“Closer to home, the UK faces similar issues: a combination of weaker-than-expected growth, higher-than-expected interest rates, and the government’s wafer-thin fiscal headroom have created a vicious cycle that will likely require some combination of tax increases and spending cuts later in the year.”

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Spiller concludes that despite governments’ commitments to fiscal consolidation, it appears bond markets will have to prepare to digest a wave of issuance over the coming years.

“The sheer weight of this issuance will create additional upward pressure on long bond yields even as many central banks reduce short-term interest rates to counter the economic slowdown,” he said.

Nevertheless, the veteran fund manager, who has run Capital Gearing for more than 40 years, says that elevated long bond yields could be an opportunity, particularly in inflation-linked bonds.

Spiller says: “These new relatively steep yield curves are a welcome opportunity. Around the year-end we started to lengthen the duration of our UK index-linked holdings into better values.

“While there is still scope for further curve steepening, historically purchasing long UK index-linked bonds above a 2% real yield has been a rewarding investment and we are watching developments in this market with interest.”