Government bonds are unattractive at current prices

The global upswing continued with strong economic. This expansion combined with only modest inflation has allowing the Federal Reserve Federal Open Markets Committee (FOMC) to withdraw monetary stimulus. The FOMC started to withdraw assets at a rate of US$10bn per month in October. The ECB has also indicated that it is preparing to taper its QE programme.

With the FOMC and potentially the ECB not renewing their bond purchases and without a central banker to pick up this supply, it is likely that there will be a significant increase in bonds on the market. Bond yields will have to rise to attract buyers and bond prices will fall to accommodate the yield rise.

The UK economy is showing signs of slowing from its growth in 2016 while inflation has picked up to 3.1% in November. The Bank of England increased interest rates by 0.25% in November against a backdrop of above target inflation and low unemployment. This rate rise lead to an increase in UK government bond yields and a strengthening of sterling.

The Feds balance sheet reductions plus the ECB’s reduction of its QE programme throughout 2018 should keep some upward pressure on bond yields. However, at current price levels, the near zero yields on government bonds are unattractive.

It is against this background that we have set out our portfolio recommendations.

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